Transcript Presentation by Ralph Dazet, CPA “If I’m Making all this Money … How Come I’m Broke?” Introduction ► Informal ► Ask questions.

Presentation by
Ralph Dazet, CPA
1
“If I’m Making all this Money …
How Come I’m Broke?”
Introduction
►
Informal
►
Ask questions
2
In the 50 years I have been
practicing accounting, this question
has frequently been asked by my
clients…
This session is designed to help
answer that question!
3
What Will our Methodology Be?
► As usual, we will use a case study – the good ole
– “Tie ‘Em Down Good Company”!
(A metals distribution company servicing the
marine and aerospace industries.)
4
Tie ‘Em Down Good, Inc.
Financial Highlights
Three Years Ended December 31, 2011
OPERATIONS
Revenue
Gross Profit
% of Revenue
Operating Expenses
% of Revenue
12/31/11
13,636,000
Year Ended
12/31/10
12/31/09
11,458,000 10,140,000
3,136,000
23%
2,750,000
24%
2,636,000
26%
2,454,000
18%
2,177,000
19%
2,028,000
20%
Pre-Tax Income
% of Revenue
682,000
5%
573,000
5%
608,000
6%
Income Tax
267,000
415,000
3%
223,000
350,000
3%
237,000
371,000
4%5
Net Income
% of Revenue
12/31/11
1,041,000
1.3 to 1
1,857,000
49 days
Year Ended
12/31/10
751,000
1.3 to 1
1,432,000
45 days
12/31/09
575,000
1.2 to 1
1,155,000
41 days
3,000,000
3.5 turns
2,124,000
4.1 turns
1,745,000
4.3 turns
810,000
704,000
600,000
Accounts Payable
Days of Purchases
1,402,000
48 days
1,064,000
44 days
917,000
44 days
Line of Credit
Collateral Coverage
2,270,000
1.25
1,619,000
1.30
1,220,000
1.40
Shareholders’ Equity
1,480,000
1,065,000
715,000
6
FINANCIAL CONDITION
Working Capital
Ratio
Accounts Receivable
Days of Sales
Inventory
Inventory Turns
Fixed Assets, Net
►
The financial statements we last examined –
12/31/11 disclosed:
 Strong sales growth;
 Strong profits; and
 Tight cash flow and a slightly nervous bank
7
What Happens in 2012?
►
Part of the dream comes through:
 Sales shoot up by 20%.
 Gross profit margin holds at 2011 margin!
 Variable operating expenses are in line with
sales growth!
 Receivables, inventory and payables are in
line with sales growth!
 The company feels they have really
managed the growth!
8
► The Stage!
The company, in an informal discussion with
the banker, assures the banker that things are
really looking good in 2012.
 Sales are outstanding!
 Profits are looking great!
 I’m sure we can knock the debt down by
the end of 2012!
9
► What will the 2012 financials look like?
The Income Statement
Let’s examine the
Summary of Assumptions used
10
Tie ‘Em Down Good, Inc.
Summary Assumptions
Year ending December 31, 2012
OPERATIONS
I.
SALES
20% growth from 2011
II.
GROSS PROFIT
Maintain 23% gross margin
Expense
III. DEPRECIATION EXPENSE
Beginning of year – fixed assets - gross
Method & life – S.L 10 yrs.
$ 910,000
$
$ 100,000
CURRENT YEAR ADDITIONS
Method & life – S.L 10 yr, mid yr convention
TOTAL
91,000
$
5,000
$
96,000
11
EXPENSE
IV.
V.
LEGAL EXPENSE
Same retainer as 2011
$
12,000
RENT EXPENSE
Same operating leases and rate as 2011
VI. TELEPHONE & UTILITIES
5% increase over 2011
Telephone
Utilities
VII. INTEREST
Working capital loan
Beginning of year
LONG TERM DEBT
Beginning of year
Less ½ payments
Average balance
$ 120,000
$
$
$2,270,000
Rate
8%
$
$
Rate
35,000
38,000
$ 182,000
445,000
(37,000)
408,000
9%
36,000
VIII. OTHER EXPENSE
$ 218,000
All other variable expenses increase at same rate as sales – 20%
IX.
INCOME TAX
Calculated at historical effective rate of 39.15%
$ 343,000
12
Based on those Assumptions, let’s
examine the Income Statement!
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Tie ‘Em Down Good, Inc.
Statement of Income
Year ending December 31, 2012
Sales
Cost of goods sold
Gross profit
% of sales
Operating Expenses
Accounting
Advertising
Bad debts
Delivery expense
Depreciation
Insurance – Group
Insurance – Casualty
Legal
Maintenance
Meals & entertainment
Miscellaneous
Office expense
Payroll tax
Rent
Telephone
Utilities
Wages – officers
Wages – office
Wages – sales
Wages – warehouse & delivery
Total
$16,363,000
12,600,000
3,763,000
23%
35,000
16,000
66,000
32,000
96,000
101,000
144,000
12,000
40,000
56,000
44,000
30,000
133,000
120,000
35,000
38,000
492,000
274,000
491,000
414,000
2,699,000
14
Operating income
Interest expense
Pre-tax income
Income tax
Net income
$1,094,000
218,000
876,000
343,000
$ 533,000
15
Wow! The sales growth and the
Company’s management of gross profit
margin and operating expenses has
produced a bottom line growth from
$415,000 in 2011 to $533,000 in 2012.
A growth rate of 28%!
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The Balance Sheet
Let’s examine the
Summary of Assumptions used.
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Tie ‘Em Down Good, Inc.
Summary Assumptions
Year ending December 31, 2012
FINANCIAL CONDITION
I.
Cash
Hold balance @
II. Accounts Receivable
Hold @ 49 days
Sales per day
Sales $16,363,000
÷ 360 days = $45,450
x 49 days
III. Inventory
Hold @ 3.5 turns
Cost of goods sold
÷ 3.5 turns
$
$
45,450
Fixed Assets
Beginning balance, net @ 12/31/11
Plus current year additions
Less current year depreciation
Net balance @ 12/31/12
$2,227,000
$12,600,000
$3,600,000
IV. Prepaids
Hold @
V.
50,000
$
$
50,000
$
814,000
810,000
100,000
(96,000)
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VI. Working Capital Loan
Hold @
$2,270,000
VII. Accounts Payable
Hold @ 48 days
Payables per day
Cost of goods sold
÷ 360 days
x 48 days
$12,600,000
35,000
$1,680,000
VIII.Accrued Expenses
Hold @
$ 170,000
IX. Long Term Debt
Beginning balance @ 12/31/11
Less payments
Balance @ end of year
$
$
445,000
(74,000)
371,000
Current
Long-Term
X.
Shareholders’ Equity
Balance – Start of year
Current year profit
Balance @ at end of year
$ 74,000
$ 297,000
$1,480,000
533,000
$2,013,000
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► Based on those Assumptions, let’s examine the
Balance Sheet (has the $533,000 bottom line
profit earned, enabled the Company to reduce debt as
promised?)
► If all of the
Balance Sheet Assumptions
come to pass and the Company generates a $533,000
bottom line, what will the resultant net increase or
decrease in cash be?
20
Tie ‘Em Down Good, Inc.
Balance Sheet
Year Ended December 31, 2012
ASSETS
Current Assets
Cash
Cash, increase (decrease)
Accounts receivable
Inventory
Prepaid expenses
Total current assets
$
50,000
2,227,000
3,600,000
50,000
5,690,000
Fixed assets, net
814,000
Total Assets
$6,504,000
21
LIABILITIES AND EQUITY
Current Liabilities
Working capital loan
Accounts payable
Accrued expenses
Current portion long-term debt
Total current liabilities
Long term debt
$2,270,000
1,680,000
170,000
74,000
4,194,000
297,000
Shareholders’ equity
Common stock
Retained earnings
Total shareholders’ equity
100,000
1,913,000
2,013,000
Total Liabilities & Equity
$6,504,000
22
-AnswerCash goes down by ($237,000)
23
Why?
With a substantial growth in sales
(example 20%), the profits generated
will not be able to self-finance the
resultant growth in Receivables and
Inventory – even if management
is able to hold this Inventory and
Receivable growth in line with sales!
24
What happens if management, in its great rush
to grow the business, allows gross profit margins
to slip a little and receivable and inventory
management to slip a little (look at history)
► We call this “the Norm”!
► Looking back over the Company’s recent
history, suppose the rapid sales growth
produces the following effect on operations
and financial conditions.
Operating Assumptions
25
Tie ‘Em Down Good, Inc.
Summary Assumptions
Year ending December 31, 2012
OPERATIONS
All Assumptions are the same as in the first illustration,
except for projected gross profit %.
This illustration assumes that the rapid growth in sales
(20%) will result in a 1% slippage in gross profit from
23% to 22%.
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Balance Sheet Assumptions
27
Tie ‘Em Down Good, Inc.
Summary Assumptions
Year ending December 31, 2012
FINANCIAL CONDITION
I.
II.
Cash
Hold balance @
Accounts Receivable
Slip from 49 days to 52 days
Sales per day
Sales $16,363,000
÷ 360 days = $45,450
x 52 days
III. Inventory
Slip from 3.5 turns to 3.2 turns
Cost of goods sold
÷ 3.2 turns
$ 50,000
$
45,450
$2,363,400
$12,763,100
$3,989,000
IV. Prepaids
Hold @
V.
Fixed Assets
Beginning balance, net @ 12/31/11
Plus current year additions
Less current year depreciation
Net balance @ 12/31/12
$
$
50,000
810,000
100,000
(96,000)
$ 814,000
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VI. Working Capital Loan
Hold @
$2,270,000
VII. Accounts Payable
Hold @ 48 days
Payables per day
Cost of goods sold
÷ 360 days
x 48 days
$12,763,100
35,500
$1,704,000
VIII.Accrued Expenses
Hold @
$ 170,000
IX. Long Term Debt
Beginning balance @ 12/31/11
Less payments
New balance @ end of year
$
$
445,000
(74,000)
371,000
Current
Long-Term
X.
Shareholders’ Equity
Balance – Start of year
Current year profit
Balance @ at end of year
$ 74,000
$ 297,000
$1,480,000
434,000
$1,914,000
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►
If the Assumptions all come to
pass, what will the financial statements
look like?
The Income Statement
30
Tie ‘Em Down Good, Inc.
Statement of Income
Year ending December 31, 2012
Sales
Cost of goods sold
Gross profit
% of sales
Operating Expenses
Accounting
Advertising
Bad debts
Delivery expense
Depreciation
Insurance – Group
Insurance – Casualty
Legal
Maintenance
Meals & entertainment
Miscellaneous
Office expense
Payroll tax
Rent
Telephone
Utilities
Wages – officers
Wages – office
Wages – sales
Wages – warehouse & delivery
Total
$16,363,000
12,763,000
3,600,000
22%
35,000
16,000
66,000
32,000
96,000
101,000
144,000
12,000
40,000
56,000
44,000
30,000
133,000
120,000
35,000
38,000
492,000
274,000
491,000
414,000
2,699,000
31
Operating income
Interest expense
Pre-tax income
Income tax
Net income
$ 931,000
218,000
713,000
279,000
$ 434,000
32
The (1%) drop in gross profit
margin reduced net income from
$533,000 to $434,000
(which is still ahead of prior
year results of $415,000)!
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Balance Sheet
34
Tie ‘Em Down Good, Inc.
Balance Sheet
Year Ended December 31, 2012
ASSETS
Current Assets
Cash
Cash, increase (decrease)
Accounts receivable
Inventory
Prepaid expenses
Total current assets
$
50,000
2,363,000
3,989,000
50,000
5,615,000
Fixed assets, net
814,000
Total Assets
$6,429,000
35
LIABILITIES AND EQUITY
Current Liabilities
Working capital loan
Accounts payable
Accrued expenses
Current portion long-term debt
Total current liabilities
Long term debt
$2,270,000
1,704,000
170,000
74,000
4,218,000
297,000
Shareholders’ equity
Common stock
Retained earnings
Total shareholders’ equity
100,000
1,814,000
1,914,000
Total Liabilities & Equity
$6,429,000
36
 Based on those Assumptions, let’s
examine the Balance Sheet.
 What has this $434,000 bottom line
from operations produced?
37
-AnswerCash goes down by $837,000 …
OUCH!!!
 If our historical trends continue, the Company
may NOT be able to finance this growth.
 Yes, Virginia…
"You can sell yourself out of business!"
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How do we solve this problem?
► Slow down sales?
 Is this an acceptable answer for almost all
companies?
► Monitor and target acceptable levels of “Days
Sales” and “Inventory Turns”
of
 Assign responsible people to monitor and have
definite reporting schedules with a set meeting
schedule (no less than once a month).
 Further slippage is NOT acceptable – the
Company cannot reasonably expect to finance a
$837,000 negative cash flow!
39
► At the start of the year, the Company must prepare,
very carefully, a realistic Operating and Cash
Flow Budget.
 All effected parties:
a. Ownership;
b. Sales department;
c. Inventory department; and
d. Accounting department
must provide input and acceptance!
40
► After this operating and cash flow budget is
prepared, management must meet with its commercial
lender and determine the lender’s approval of the
Company’s plan and obtain from the lender a
commitment of their participation.
► If management anticipates continued future growth of
this magnitude, the Company should begin to explore
additional sources of capital.
 Expanded investment from existing stockholders.
 Possibility of investment by individuals who are
willing to be minority shareholders.
 Venture capital groups.
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Let’s not lose sight of the best solution!
► Management learns to manage the Balance
Sheet as well as it manages the Income
Statement!
► What would happen if instead of “holding
our own”, the Company actually improved
its management of:
42
Tie ‘Em Down Good, Inc.
Summary Assumptions
Year ending December 31, 2012
FINANCIAL CONDITION
I.
Cash
Hold balance @
II. Accounts Receivable
Improve to 45 days
Sales per day
Sales $16,363,000
÷ 360 days = $45,450
x 45 days
III. Inventory
Improve to 4.1 turns
Cost of goods sold
÷ 4.1 turns
$
$
45,450
$2,045,400
$12,600,000
$3,073,000
IV. Prepaids
Hold @
V.
Fixed Assets
Beginning balance, net @ 12/31/11
Plus current year additions
Less current year depreciation
Net balance @ 12/31/12
50,000
$
$
50,000
$
814,000
810,000
100,000
(96,000)
43
VI.
Working Capital Loan
Hold @
$2,270,000
VII. Accounts Payable
Hold @ 48 days
Payables per day
Cost of goods sold
÷ 360 days
x 48 days
$12,600,000
35,000
$1,680,000
VIII. Accrued Expenses
Hold @
IX.
$ 170,000
Long Term Debt
Beginning balance @ 12/31/11
Less payments
Balance @ end of year
$
$
445,000
(74,000)
371,000
Current
Long-Term
X.
Shareholders’ Equity
Balance – Start of year
Current year profit
Balance @ at end of year
$ 74,000
$ 297,000
$1,380,000
533,000
$1,913,000
44
“Days of Sales” from
49 days to 45 days
“Inventory turns” from
3.5 turns to 4.1 turns
What would the Balance Sheet look like
then? (Remember when the Company
“held its own”, with a 20% growth,
the $533,000 net income turns into a
$(237,000) negative cash flow.
45
Tie ‘Em Down Good, Inc.
Balance Sheet
Year Ended December 31, 2012
ASSETS
Current Assets
Cash
Cash, increase (decrease)
Accounts receivable
Inventory
Prepaid expenses
Total current assets
Fixed assets, net
Total Assets
$
50,000
472,000
2,045,000
3,073,000
50,000
5,690,000
814,000
$6,504,000
46
LIABILITIES AND EQUITY
Current Liabilities
Working capital loan
Accounts payable
Accrued expenses
Current portion long-term debt
Total current liabilities
Long term debt
$2,270,000
1,680,000
170,000
74,000
4,194,000
297,000
Shareholders’ equity
Common stock
Retained earnings
Total shareholders’ equity
100,000
1,913,000
2,013,000
Total Liabilities & Equity
$6,504,000
47
► As disclosed in the following illustration, the net effect of
the improvement in receivable “Days of Sales” and
“Inventory Turns” would convert to a negative cash
flow of $(237,000) to a positive cash flow of $472,000.
► Is this possible?
 The 45 Days of Sales in the illustration merely returns
to 2010 results.
 The 4.1 Inventory Turns in the illustration merely
returns to the 2010 results.
 It should be noted that these results are in the mid-range
of performance for the metals distribution companies in
the Robert Morris survey and the Metals Distributors
Trade survey published results.
48
How Can We Best Monitor and Improve
Performance in this Cash Flow Area?
► Review past history and use this understanding to
predict future results.
► Improve our ability in projecting cash flow.
► Develop acceptable “benchmarks” of performance.
 Assign responsible management personnel to monitor
and report on these results with a formal meeting
schedule.
 Develop a reward system for acceptable performance.
49
►
Develop a program to meet with the
Company’s commercial lender in advance,
and
 Lay out the Company’s expected operating results and
projected cash flow results.
 Obtain a commitment from the lender that they are
willing to meet our commercial lending needs for the
following year.
50