in Investment Know How

Controlling is a key aspect for each new venture. It starts out initially with a solid understanding of cash flows and moves across various phases as a business growths. In my experience the key aspects for each venture development stage can be summarized with the following headlines:

  1. Liquidity awareness
  2. Profitability measures
  3. Balance sheet optimization

Each of these three steps requires different controlling techniques and management focus on various aspects of the business. As a venture develops it is not only these above mentioned points but also controlling techniques for each key business resource that will keep management busy.

Also be aware that, “measures” and “optimization” have been picked on purpose – your role as a CFO will change with each of the steps listed above. You will move from making decisions that might be bad for profitability but good for liquidity to pure financial engineering actions that will optimize your balance sheet. This also requires a move in your strategic thinking from survival (liquidity), to operations (profitability) to strategic, long-term goals (balance sheet and capital structure optimization).

eCFO Tip: Controlling is all about data ANALYSIS and FOLLOW-UP ACTION. If you cannot effectively collect, store, organize and eventually analyze data you will not be able to install effective controlling measures. Nevertheless, be mindful that all too often management will focus on the process of collecting, storing and organizing data and will forget that the key aspect is the analysis and the changes/learnings/actions you derive from it! Action trumps collection!

Liquidity awareness

As mentioned in previous posts this is a key aspect for each new venture but how do you actually make sure that you are aware of liquidity issues? Based on my experience you can do the following:

Compile a weekly Excel spreadsheet that lists all liquidity in- and outflows for the next 8 weeks. Here it does not matter if it is tax, P&L relevant or a rent deposit – any payment that comes in or goes out is traced. This will provide you with a solid understanding of when you will be running low on cash for the next two months.

This will require that either yourself or an extremely reliable employee is fully aware of all payment cycles (salaries, subscriptions, taxes, customer payment discipline etc.) in your business. It also goes beyond a simple accounting measurement since the person compiling these numbers will have to be aware of all operational aspects of your business. As your business continues to grow, it will be increasingly difficult to get every department head to provide the necessary information – make sure that you install well-thought out reporting structures early on. If people are used to providing information from the get-go, it will save you a lot of trouble later on.

eCFO Tip: Be aware of cash accounts outside of your normal banking activity. Paypal, AdWords/Sense, Affiliate accounts, Amiando, e-commerce shop accounts etc. can be a significant source or drain of cash. Make sure that each employee notifies either you or your team when a new account is created. Every account that uses cash should be treated as you would treat a regular bank account. I am sure as CFO you wouldn’t allow everyone to open a bank account by themselves – why should it be different for these accounts?

In addition, I would recommend that every serious CFO does the following to make sure that liquidity is well understood within the business:

  1. Check bank balance and transactions for each account EVERY day
  2. Control any payment that is made as long as the business is below a revenue of EUR500.000 p.a. / once it is above that revenue figure install a limit for each employee e.g. EUR100 per transaction which can be processed without your explicit consentJ
  3. Be fully aware of every invoice that is issued and when a customer is expected to pay

eCFO Tip: I have found a range of great SAAS products that support this process. Remember it is not your job to collect, store and prepare data for an analysis – as CFO you have to act on this data! Personally, I like the functionality of:

a) for organizing my invoices

b) for time tracking and budget planning

c) as CRM tool

Using a SAAS tool makes it fairly easy and inexpensive to keep track of your key data. Confidentiality here is also very important but in general these tools have solid user controls and are well protected from possible hacker attacks – even though there is of course the risk that your data is stored on a server that is not under your control.

Profitability measures

Once a venture has been able to either secure significant financing or cash generation has reached a point where closely monitored liquidity control is no longer a key aspect for survival, profitability moves more and more into focus. Here, it is important that the CFO fully understands all profitability enhancement techniques and makes sure that a good understanding for percentages is established. What I mean by that, is that certain key measures such as staff cost as a percentage of sales, EBIT margin, travel expenses as % of sales, etc. should always move within a certain range – once they move outside of this range you need to take corrective measures. Here a step-by-step recommendation:

  1. Reduce focus on liquidity by implementing liquidity checks every other week or even every three weeks – never completely stop since your liquidity situation might change
  2. Budget planning – there will be a whole additional post on this topic so I will stay brief here – you need to get a good understanding of the 12 months forecast. It does not matter if you actually hit these numbers. What does matter is that you can compare your actual vs. planned numbers and understand why they might be different. You can either go bottom-up or top-down on this forecast. Again the method is not that important – it is more important that these numbers are agreed upon by everybody who can actively influence them (top, middle management at least) and that they are regularly reviewed.
  3. Check out comparable companies and talk to CFOs of larger businesses from your industry. They will have a good understanding of what these percentages should be, once the business has matured. As an example: we work a lot with service agencies and therefore our HR costs should be approximately 80-90% of all operating expenses – if we are significantly below or above we are either underpaying (never!), waste too much money (very likely!) on other expenses or something else is going wrong – now it would be the CFO’s task to find out what exactly is causing the discrepancy.
  4. Make sure that you get a carefully prepared monthly P&L overview from your accountant so that you have a fairly reliable set of numbers. Make sure that you are familiar with every line item!
  5. Check, check and check again – calculate some key ratios every month. Check through each statement your accountants send to you.
  6. In the end profitability is simple – you need to make more money than you spend.

There are two major things you can do:

  1. Earn more money (increase sales, increase prices for existing products/services and so on)
  2. Spend less (do you really need: company cars, a desk, new offices, coffee maker that can make latte, Apple computers, , lawyers etc.)

ANY measure you take will either influence A or B – what you specifically do or how creative you get is up to you.

Comes back to an old CFO joke: a young CFO gets hired and the old, experienced CFO gets fired. The young gun asks the old guy: any tips? The old guy gives him three letters and tells him to open each letter if the business is performing really badly and he is suffering. So time goes on and things don’t go well. The young guy opens the first letter: It says “increase sales” and the young guy goes out and does everything in his power to pump up sales – nothing works. He opens the second letter – it says “cut costs” so he cut costs like Warren Buffet himself and cuts and cuts and cuts – no success. So he decides to open the last letter. It says: write three letters!

eCFO Tip: Don’t have blind trust in your accountants – meet them at least every two months and explain your business model, each large project and what you do – only if you do that  will they be able to prepare correct statements. They are not part of your business – especially if you work on innovative projects or in new technologies such as Facebook, Google etc. Therefore, they will not have a strong operational understanding.

I had a long chat with our accountant about Facebook fans we acquired in our internal, generic Facebook groups for later advertising purposes. The question was, whether this wasa pure operating expense or were we actually generating lasting value that should be depreciated over time – there is no rule, no case study and no exact guideline for this. Nevertheless, if your accountant understands the concept she can apply “old” rules to “new” technologies and that might be very positive for your business.

Also make sure that you do not only talk with the head of the company or some senior members –training and discussion should be aimed towards the employees/accountants who actually work with your numbers every day. They are the ones who make the decision how something should be booked in the first place – so they need to be informed first.

Balance sheet optimization

By now you should be feeling pretty good about yourself. You have conquered liquidity problems and you are running a highly profitable business. Now it’s time for the real CFO stuff – balance sheet optimization and financial engineering. Before you call Goldman Sachs and invest into derivative products I would recommend that you fully understand what you are trying to achieve – you have probably gone for the low hanging fruits of liquidity and profitability with nothing more in mind than survival and solid operational goals.

Balance sheet optimization is far more strategic. There is no right or wrong answer to: “What should my optimal capital structure be?” “Which assets should I show on my balance sheet?” “Equity vs. assets vs. liability ratio analysis.” “Should I lease all my equipment or buy?” “Rent or build office space?” In order to be good at this you need at least a strong three-year strategy that guides your action – do you want to increase your debt level, sell the business, acquire other businesses etc. These are all questions that will determine how your balance sheet should be build. Remember that all the financial engineering is not worth anything, if it does not lead towards a specific goal.

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  • Chris

    Excellent post. I especially like the tips and the clear structure. Thanks!