SOPHISTICATED FINANCE

Financial Reporting Standards

A CFO recently told me that his monthly financial statements had a $1 million error in gross margin. Not so uncommon in a first draft, but five of his subordinates had already reviewed the statements and nobody caught the error (5 college graduates, 4 degreed accountants, 2 CPAs). The possible reasons for this breakdown include:

1. Unqualified employees
2. Untrained employees
3. Too much work
4. Failure to analyze the financial statements
5. Unclear responsibility to review financial statements
6. A lack of standards

In my experience people normally assume that 1 or 2 explain the problem. In fact, poor management reporting can highlight any of the six possible causes. Poor management reporting is one of the best indicators of company wide problems that I know of. Each of the six reasons highlights a larger issue in either human resources, operations, management or leadership.

I think that 1-5 are more obvious in how they relate to management disciplines, but perhaps standards requires further discussion. To what standard do you prepare your financial statements? There are three choices in reverse order of importance:

1. GAAP (Generally Accepted Accounting Principles)
2. Accurate (reflecting not only the form but also the substance of the transaction)
3. Not misleading to the reader (the SEC's standard)

Most executives would say that they follow GAAP. This is a somewhat naive approach. Conforming to a particular accounting pronouncement fails to necessarily confirm that the substance of a transaction has been captured. If you pick the wrong pronouncement to account for a transaction, you follow GAAP but miss the transaction. For example, accounting for a transaction as a liability when it is really a derivative is a case where GAAP is followed but you have missed the substance of the transaction. Failure or slowness to recognize an impaired asset might be a case where the accounting is accurate but totally misleading. One could argue that the timing of an impairment is very subjective, which is exactly why the SEC sets their standard at "misleading". The standard for financial reporting is not GAAP or accuracy but the higher standard "to not be misleading". Establishing this standard, communicating it and enforcing it is the responsibility of both the CEO and the CFO and is a critical leadership responsibility.

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Miami, FL

Upcoming FIU Workshop--Financial Plans

I am beginning my third year of presenting workshops for the Pino Entrepreneurship Center at FIU (where I teach). My most popular workshop is on preparing a financial plan for a business, which is being offered on August 13. The morning session is devoted to how to develop a business model and the afternoon focuses on how to integrate the business model into the financial plan. I will be using a new model for the afternoon session, which is a social media company. Details are here. The nominal fee goes to Pino.

I have also agreed to a workshop in the fall on "Accounting for the Non-financial Executive". Pino challenged me to see if I can come up with an entertaining and practical workshop. I will rise to the challenge!!--with a whole new repertoire of war stories and jokes. If you slept through accounting, can't read a balance sheet or just want to see me make accounting not be boring, stay tuned here. I will announce this historic event with plenty of notice.

I would also remind any student readers that I will be teaching HFT 4292C--Entrepreneurship--this fall. The course is a little theory, a lot of practical and a lifetime of stories and examples. The jokes are free.

Miami, FL

Guest Post: Who is Managing The Business of Your Business?

With so much success from the Rickert Warnelid guest posts (here and here) on project finance and financial modeling, I have been actively seeking out new guest bloggers for here at SF. I met Deborah Koch, Senior Vice President of Gibraltar Bank in Miami, at a breakfast networking event. Gibraltar Bank focuses on serving small and middle market private companies and entrepreneurs. Deborah's understanding of entrepreneurs impressed me so I asked her to do a guest post, which follows.

Remember your first and probably second years in business?  You wore many hats --- CEO, Sales Manager, HR Director, Operations Coordinator, Purchasing Associate, and Receptionist, just to name a few.  You took on these diverse roles to efficiently launch your dream; either you couldn’t afford to hire professionals for these jobs, or just wanted to do it your way.

 

In short, you ran the business of your business.  Somehow, you carried this off in addition to delivering the special skill that drove you to start your company, whether it be as an inventor, consultant, writer, plumber, or chef.  

 

This is a common entrepreneurial dilemma…how do you maintain and grow your business and deliver your unique value proposition?  Can you be adept at both?  

 

We all know success stories that make the answer to this question a resounding YES; however, these people are not successful by accident.  A close friend who runs a CPA firm told me it was years before he trusted anyone else to make business decisions, but eventually he was so busy being a CPA that he had to hire a professional manager for the firm. In those early years, he spent many late hours tending to routine responsibilities necessary to keep the firm on the right path --- everything from ordering office supplies to paying the bills and hiring staff. 

 

When you are ready to share your dream, here are a few tips to help you grow into your role.

Trust.  Hire smart people whom you trust.  Letting go is much easier when your staff is empowered to perform.

 

Delegate.   If you trust your team, let them do what you hired them to do.  They may do it a little differently than you would have, but you never know, it just may turn out better.

 

Plan.   At least once annually, take time away from the office to plan for the next year, next five years, next ten years.  Include your management team however large or small the group.

I like the clarity and elegance of Deborah's advice. Maybe we can have her back for more guest posts.

Social Media Correlates with Faster Revenue Growth

ReadWriteWeb reported on a study that documents a correlation between faster revenue growth and increasing use of social media by the top 100 international brands. "Those brands that were the most engaged saw their revenue grow over the past year by 18% while the least engaged brands saw losses of negative 6%."

The companies in the study are both consumer and business oriented and include Starbucks, Dell and SAP. "The study grouped the brands into one of four engagement profiles that related to the number of channels they're involved in and how deep that involvement is", as shown below.

The study includes detailed case studies on some of the companies with the greatest use of social media, such as Dell and Toyota. There is a link where you can rate your company's use of social media. You also have the option to enter your company information in the database and become part of future studies.

If the big companies are using social media effectively, then they will be training customers to expect customer service responses from Twitter complaints, forums to discuss new product feature wishes and many informal channels of communications between employees and customers. Startups will need to come out of beta stage with these customer services in place or they may not get the traction they are expecting.

The full report is here. Download ENGAGEMENTdb_Report_2009

How to be a CEO

Scott Davis, @scottatlyzasoft, was nice enough to retweet my post Make Things Simple, which led me to his blog. His blog, Circumspecting: People, Tech and Business is a thoughtful combination of strategy, operations and tech.

His most recent post, Yo-Yo's Make the Best Leaders, talks about the need for the CEO to function at multiple levels, including operations. The American education system devotes little time to operations--that boring stuff like manufacturing, warehousing, logistics, sourcing, customer service, etc. Instead, we train future executives in branding, corporate culture and Wall Street dealmaking, to name just a few lower value-added activities.

I have consistently talked about the need for companies and especially the CEO to be customer focused. I learned this principle in the retail industry. Visiting stores allows you to see and meet customers face to face, observe how they shop and see first hand the customer reaction to merchandise. Stores also allow you to visit operations and observe inventory levels, outdated merchandise and store housekeeping. When I ran a retail company I spent 1-2 days every week visiting my stores and the competition. Wal-Mart executives do the same thing, every week.

If your business model involves widely disparate customers, then spend time every week in customer service. You will learn more about your own operations, the frequency of customer complaints and the image your company presents to the customer than any financial report will ever tell you. When I ran a telephone company, I would spend one day a week (usually two hours per day) in customer service. It was absolutely the most effective time I spent each day because I was able to learn first hand about the customers and the operations that served them.

So as Scott might say, "yo-yo between CEO stuff, the customers and operations". You will be a much more effective CEO.

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Miami, FL

Lessons from Blackstone Group

PE Hub has a great post this morning on the annual meeting of the Blackstone Group. Blackstone describes itself as an alternative asset management company with $92 billion under management. However, Blackstone's beginnings were as a private equity fund and they built their reputation doing LBOs.

A few quotes from Blackstone illustrate some important lessons.

1. “You almost never screw up by replacing a CEO, but keeping a weak one can be devastating.” Weak management has untold, continuing consequences. When you have a problem with a manager, replace them. The higher in the organization the more resolve you should have to replace them quickly.
2. "Blackstone’s largest-ever equity check was in the Hilton Hotels buyout. Its $1.44 billion investment was marked down by 48.68% as of 12/31/08." Write off or write down bad assets. Weak accounting is a black cloud that hangs over a company. Also, if you take the write downs now they are behind you. In sailing they say to reduce sail the first time you think you need to. Write off assets at the first sign of a decline in value or create a reserve.
3. “When things do turn, we will be rapid commiters of capital, similar to 2003 and 2004. Until then, we will be very cautious exposing LPs’ capital, with the exception of purchasing debt at significant discounts.” When the economy turns up there is a huge pool of capital now on the sidelines waiting to invest again. When Blackstone makes a new, large investment (say over $500 million) in a company, that will be a signal that Blackstone thinks the economy has turned.

Miami, FL

Make Things Simple

Howard Lindzon, hedge fund manager, investor in Twitter, constant critic (deservedly) of CNBC and blogger, had one of his usual market analysis posts this morning. In each of Mr. Lindzon's opinionated posts there is always a single gem of wisdom, unless you are actually interested in understanding the stock market (which he discusses thoroughly and insightfully on an almost daily basis). Today's gem was the following quote:

"People love to make things difficult."

If you have read this blog for awhile, you have hopefully come to realize that I am a simple (simpleton?) thinker. I do not have the kind of mind that can analyze problems in sixteen dimensions. In fact, more than two or three dimensions to a problem and I get short tempered and a bit surly. Complexity drives me crazy. My startup and early stage clients, on the other hand, seem to heartily embrace complexity. Two examples will illustrate my point.

1. A struggling, very cash flow negative client has decided to pursue a joint venture in Japan as the means to turn around the business. I worked in Japan for ten years and arranged five joint ventures there. As one of my staff used to say, "there is no technology yet invented that can measure that complexity of doing business in Japan". Should only take 12-18 months to get a joint venture signed, if it ever does get signed. Not a realistic turnaround strategy.
2. Another client is a desktop software company with about 22 free users and no real plan for how to get more users except "raise a big round of VC money". The product development strategy showcases their love of complexity. Launch download version of desktop product, build and launch SAAS version, offer in-the-cloud storage for clients (think Google Docs) and physically distribute software in Europe. And this is just the 12-18 month plan. Maybe they are going to outsource company management to Google or Microsoft.

Two sure ways to tell you have over complicated your early stage business:

1. Have an international expansion strategy
2. Have multiple product (not feature set) launches in the same year

There are probably sixteen other ways to tell if your business model is over complicated, but let's keep this post simple.

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Miami, FL

Train Like the Military

This morning I had breakfast at a 5 star hotel which is an international chain renown for its customer service. The hotel was not very busy, probably reflecting the current economic conditions. After the meal my host and I both commented on how bad the service was. Staff was generally inattentive and the service was slow--very slow. It appears that the hotel has let its standards slip because it is not very busy.

The military faces a similar situation. They are not always in combat but they have to be prepared to go on short notice. To keep skills sharp even when there is no combat, the military trains constantly. Constant training saves lives.

In this period of slow economic growth, rather than letting standards slip, perhaps you should increase training. The time is available, the people are not so stressed from daily tasks, and training sub-consciously sends a message that you think business is going to pick up.

A previous post on military type training is here.

Miami

A Great Example of Outsourcing

I am a big proponent of outsourcing for several reasons:

1. It reduces capital requirements
2. It simplifies management
3. It allows management to focus more time on the critical factors to grow the business

Of course, the key to successful outsourcing is the ability to identify what the non-critical factors are. Most management teams never really think about what is or is not critical and never seem to get around to outsourcing and simplifying management of the business.

From the earliest days in telecom, the engineers who ran telcos always considered the network a critical component of the business and fiercely protected their ownership of this hardware and infrastructure. I have always thought that network operations should be outsourced because network rarely gave you a competitive advantage.

Yesterday Sprint announced that they are outsourcing their network operations to Ericcson. Ericcson is the largest network outsource company in the world and currently operates the networks for 275 million international wireless subscribers, including portions of the Vodaphone and Digicel networks.

Now one could argue that Sprint is poorly managed and should not be cited as an example of a good management decision. Hey--everybody makes a good decision once in awhile. Notice what Sprint made clear they were retaining--customer experience, customer technical support and services review. These are the differentiating factors in modern telecom. I think Sprint thought out this switch to outsourcing thoroughly and made the right decision. Might even consider buying the stock!

Now if Sprint can outsource its huge (huge!) network, maybe you could switch your business to the web version of Quickbooks, Google mail or Salesforce.com. It's not that hard. You can do it... and, by the way, maybe your company email will even work:) After that, look into AWS.

(I just noticed that Amazon Web Services use the TypePad blogging service. One of the most technologically sophisticated companies outsources for blogging technology. Might be a lesson there!)

I found the news about Sprint on Fierce Wireless, an excellent telecom blog.

Miami, FL

Build Blog Traffic--A Tip

This morning I tried a new technique to bring traffic to this blog and it worked really well.

@IndianStartup posted a link on Twitter to a very good post on Entrepreneur Corner about startups and valuations. After reading the article I sent @IndianStartup a Tweet for a link to my blog category for startups with #entrepreneurship. The number of people that hit the blog immediately was noteworthy. Response would probably have been spectacular if I had done it later in the day and not at 715 am.

If you write a blog, you probably have your posts categorized by topics. For example, I have categories for Excel, venture capital,financial crisis, etc. A list of all categories is here (scroll down). Rather than sending people links to a specific post, send a link to a blog category and show off all your work on the topic.

Miami, FL

Multi-tasking is Over Rated

With the proliferation of technology multi-tasking has become the accepted norm. I have never been a multi-tasker. I prefer to focus on a single project and complete it as early as possible. In fact my ability to focus is such that I have always had to train my assistants to make sure I was paying attention to them when they spoke to me. This singular focus has always helped me to produce quicker, well thought out results.

I also set aside time every day just to think. Usually I ponder complex client problems or intellectual issues (and the occasional blog post). I once spent two whole days thinking about how to build a financial model with 20 operating units. I have found over the years that conclusions can improve with about a two day dormant period where you consider a problem only sub-consciously. Don't be so quick to come to a conclusion on a complex problem.

I have also found that good solutions are simple. Complicated solutions usually signal a problem that is not well thought out or an unrealistic conclusion. The three billionaires I worked for were all very simple in their approach and the best CFO I know treats even a complex international tax problem in a simple 2-3 step approach.

Most of the entrepreneurs I meet glory in their ability to multi-task, rarely just sit and think about a problem for a few hours and invariably have the most complex, totally unrealistic solutions I have ever seen. The lessons that need to be learned are:

1. Focus on one important project at a time and ignore everything else; if it will not put you out of business it is not really important
2. Make time everyday without distraction just to think; for example, 5-7 am is a great time to do it because you are fresh and nobody is in the office
3. Force yourself to articulate a solution simply; 2-3 bullet points will usually explain anything adequately and let staff fill in the blanks (trusting the staff also motivates them)
4. Hire staff that are self-directed, independent thinkers so they are less likely to interfere with 1-3 above

Hopefully these tips will lead to better execution, which is half the battle in any start up.

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Miami, FL

A Readership Question

I start every day between 5-6 am by checking my blog stats for the previous day, reading the over night emails, checking Twitter (which is increasingly becoming an efficient way to follow certain topics of interest to me) and reading about 100 blogs. Every day I find 2-3 blog posts that I forward to friends, clients and even prospects and I retweet articles a few times a week. 2-3 times every year I see an article that everybody should read and I email it to a special list of about 500 business contacts. This technique also let's people know I am alive and... ready for their referrals of business.

My issue is nobody ever sends me any articles to read (except for the occasional student brown nosing the teacher). How can I have a "social network" in the thousands and rarely does anybody send me an article they think I might find interesting. Admittedly from a low base level, some people even say my social skills are improving (with age) after many years as an Asian hermit. Most of you never knew me in my mono-syllabic Asian period so you really do not have an excuse for not sending me things you think I might find interesting. I can always send you to spam after a few articles...just kidding.

If you don't receive emailed articles from me you can always follow what I think is noteworthy on FriendFeed (rhhfla) and Delicious (rhhfla). For a more social dialogue, there is Twitter (rhhfla).

Miami, FL

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4th of July-Rememberance

As we prepare for the 4th of July I would like us all to remember Ed "Too Tall" Freeman who died this week in Idaho at 80. Mr. Freeman received the Medal of Honor during the Vietnam War and his citation is here. The MOH is the highest U.S. military honor and has only been awarded 3,462 times since it began during the Civil War.

All of the recipients of the MOH demonstrated extraordinary levels of selflessness and heroism. In this day and age selflessness is almost unheard of and heroism is rare. We should remember these values and Ed Freeman. These are the values that helped to establish the independence and democracy we celebrate every 4th of July.

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