There are a number of business practices that make a company successful in both good and bad economic times. Included are great leadership and management, high quality employees and, of course, great products and services. There is often even a little good luck. This article is not about these attributes. Instead, it focuses on several key financial management and accounting practices that we have observed in successful companies during the past 30 years that have proven effective in any industry or economic cycle.
Cash flow management
Successful companies treat cash as king. They maintain sufficient cash reserves to cover normal forecasted working capital needs through the year, to manage unexpected expenses, and to take advantage of opportunities as they arise. They are extremely proficient at collecting receivables and they pay timely, take advantage of key discounts, and manage planned daily investments. They effectively use bank credit lines, not from a position of dependence, but as a key management tool. Their entire cash management system is fully integrated to all aspects of the business.
Break-even point management
Successful companies are able to properly manage through economic cycles by fully understanding the drivers of their break even point. When sales decline, it is critical to understand what costs are fixed, variable or semi-variable and what combination of each is needed to maintain a profitable position. A financial model that allows for instant decision-making about cost cutting measures or product pricing can give management the confidence and opportunity to substantially impact both short and long-term financial results.
Internal accounting controls
Not usually the most exciting aspect of business operations, successful companies value internal accounting controls. They demand that reconciliations to bank accounts and subsidiary ledgers be performed accurately on a timely basis. They understand the importance of segregation of duties and proper oversight and review in preventing problems and they know that management decisions are much better when based on accurate, reliable financial information. It starts with the “tone at the top” and permeates through the entire organization that accuracy is critical and adherence to prescribed record-keeping systems are as important as quality control on the production lines to ensuring company profitability.
Proper use of leverage and financing
Successful companies understand how to use debt as a tool to grow and generate higher returns on equity. They keep debt well within their ability to manage it, and they avoid allowing debt or debt terms to manage their operations. This requires using debt pursuant to a well-designed plan, rather than resorting to debt to fix problems.
Timely and accurate financial reporting
Successful companies typically generate accurate financial statements on a monthly basis no later than five days after the end of the month and, with the advanced electronic software systems in use today, often produce accurate financial statements on the first day following the end of a reporting period. The financial reports are typically augmented with a clear, concise dashboard-type report that summarizes the key business financial drivers. Nimble management decision-making requires timely data in a format understandable to management.
Budgeting and business plans
Written plans complete with well thought out financial projections and detailed budgets provide a mechanism to keep management focused on the end results when encountering the normal twists and turns that every year typically brings. The budget development process requires management to focus on all of the necessary processes essential to success. And, budgets provide an excellent barometer each accounting period from which to benchmark progress toward the desired goals. Successful companies put a lot of thought into these plans and not surprisingly end up achieving their goals much more consistently.
Too many times, increasing sales and profits lead to increasing extravagance and waste. A disciplined, thrifty approach to controlling expenses can provide significant downside protection in declining economies and allow maximization of profits under any conditions. For example, a company with a 20 percent variable gross margin on its products would need to generate five dollars in sales for every dollar of unnecessary or wasted cost to just break even. Little things can count a lot. Some of the areas with the most impact include health insurance plan structure, information technology management, telecommunications, auto and truck fleet costs, and overall fringe benefit programs.
Effective tax planning
Successful companies optimize tax savings opportunities to fit their business plans, rather than focusing their business plans around potential tax savings strategies. In today’s environment, income taxes can drain up to 45 percent of a company’s annual profits. Taking prudent advantage of all available tax benefits can substantially improve the return on investments within the company and accordingly, create free cash flow. Bonus depreciation is a perfect example in 2011. Effective use of this opportunity can reduce the cost of capital substantially, but fixed asset additions solely to save taxes can create excess capacity and greatly expand the break-even point.
Managing value drivers
A business’ value is often determined by its productive use of capital, liquidity, cash flow, and quality of its assets. Successful companies understand the drivers of total value in their company. Commissioning a business valuation by a Certified Valuation Analyst can provide a roadmap of the critical valuation drivers for your business, which can serve as the basis for long-term business plans.
Mastering the practices above will not guarantee the success of your company, nor will ignoring them automatically lead to failure. However, based on our observations of clients that seem to weather recessions and experience consistent profitability, these attributes are common to all.
Your CPA can assist with implementing these practices.
Content contributed James E. Hazel Jr., CPA, shareholder and chief operating officer of Elliott Davis, PLLC, an accounting, tax and consulting services firm. Jim serves clients in a variety of areas including manufacturing and distribution, construction, and not-for-profit, and provides management oversight of the firm’s 10 offices throughout the Southeast. For more information, contact him at email@example.com or visit www.elliottdavis.com.