Estimates vs. Actuals: Was Your 2018 Budget Reasonable?

As the year winds down, business owners can be thankful for the gift of perspective (among other things, we hope). Assuming you created a budget for the calendar year, you should now be able to accurately assess that budget by comparing its estimates to actual results. Your objective is to determine whether your budget was reasonable, and, if not, how to adjust it to be more accurate for 2019.

Identify notable changes

Your estimates, like those of many companies, probably start with historical financial statements. From there, you may simply apply an expected growth rate to annual revenues and let it flow through the remaining income statement and balance sheet items. For some businesses, this simplified approach works well. But future performance can’t always be expected to mirror historical results.

For example, suppose you renegotiated a contract with a major supplier during the year. The new contract may have affected direct costs and profit margins. So, what was reasonable at the beginning of the year may be less so now and require adjustments when you draft your 2019 budget.

Often, a business can’t maintain its current growth rate indefinitely without investing in additional assets or incurring further fixed costs. As you compare your 2018 estimates to actuals, and look at 2019, consider whether your company is planning to:

  • Build a new plant,
  • Buy a major piece of equipment,
  • Hire more workers, or
  • Rent additional space.

External and internal factors — such as regulatory changes, product obsolescence, and in-process research and development — also may require specialized adjustments to your 2019 budget to keep it reasonable.

Find the best way to track

The most analytical way to gauge reasonableness is to generate year-end financials and then compare the results to what was previously budgeted. Are you on track to meet those estimates? If not, identify the causes and factor them into a revised budget for next year.

If you discover that your actuals are significantly different from your estimates — and if this takes you by surprise — you should consider producing interim financials next year. Some businesses feel overwhelmed trying to prepare a complete set of financials every month. So, you might opt for short-term cash reports, which highlight the sources and uses of cash during the period. These cash forecasts can serve as an early warning system for “budget killers,” such as unexpected increases in direct costs or delinquent accounts.

Alternatively, many companies create 12-month rolling budgets — which typically mirror historical financial statements — and update them monthly to reflect the latest market conditions.

Do it all

The budgeting process is rarely easy, but it’s incredibly important. And that process doesn’t end when you create the budget; checking it regularly and performing a year-end assessment are key. We can help you not only generate a workable budget, but also identify the best ways to monitor your financials throughout the year.

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Practice the Fine Art of Inclusion at Your Holiday Gatherings

It’s that time of year, business owners — a time when you’re not only trying to wind down the calendar in profitable fashion, but also preparing year-end financials and contemplating next year’s budget.

And amidst all this, you likely have a holiday employee gathering to plan. This seemingly innocuous task can be just as tricky as the rest. It’s imperative to practice the fine art of inclusion at holiday parties so everyone feels engaged and rewarded for their hard work. Here are some ways to do so:

Involve staff in the planning. Have workers of different faiths and cultures serve on your holiday party committee. Be sure to incorporate as much of their personal holiday traditions as possible or employees may feel like they wasted their time participating on this task. By sharing family customs, workers will get to know one another better.

Celebrate differences. Rather than prohibiting all holiday-specific ornamentation in your office or at your holiday party, allow an assortment of decorations that reflect your staff’s varying traditions. And encourage employees to bring in their favorite holiday treats for all to sample. This is a great opportunity for workers to learn more about other cultures.

Say thank you to everyone. Food, drinks and bonus checks have become a holiday party focal point for many businesses. But, remember, there’s real power in explicitly saying thanks to workers. Doing so can range from passing out holiday cards with handwritten messages (from ownership or a direct supervisor) to having each department head give a presentation remarking on everyone’s individual achievements.

Pay attention to details. Like most work matters, details count — especially when planning a party. Here are some questions to ask when setting up your event:

  • Does the space or facility accommodate disabled people?
  • Are you serving nonalcoholic drinks and food for vegetarians or others with special dietary needs?
  • Could anyone find “funny” speeches or “roasting” of certain employees offensive?
  • Does the party’s date conflict with any worker’s religious beliefs?

In worst cases, a poorly planned holiday party can end up hurting morale and even triggering legal expenses if someone feels particularly excluded or offended. On the brighter side, a fun and inclusive gathering can conclude the year on a wonderful note. Let us help you manage the cost-effectiveness (and just plain effectiveness) of your company’s employee engagement activities.

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Make New Year’s Resolutions to Improve Profitability

Many people scoff at New Year’s resolutions. It’s no mystery why — these self-directed promises to visit the gym regularly or read a book a month tend to quickly fade once the unavoidable busyness of life sets in.

But, for business owners, the phrase “New Year’s resolutions” is just a different way of saying “strategic plans.” And these are nothing to scoff at. In fact, now is the perfect time to take a critical look at your company and make some earnest promises about improving profitability in 2019.

Ask tough questions

Begin by asking some tough questions. For example: How satisfied are you with the status quo of your business? Are you happy with your profitability or had you anticipated a much stronger bottom line at this point in your company’s existence? If you were to sell tomorrow, would you get a fair return based on what you’ve invested in effort and money?

If your answers to these questions leave you more dissatisfied than pleased, your New Year’s resolutions may have to be bold. This doesn’t mean you should do something rash. But there’s no harm in envisioning next year as the greatest 12 months in the history of your business and then trying to figure out how you might get there.

Rate your profitability

To assess your company’s financial status, begin by honestly gauging your current performance. Rate your profitability on a scale of 1 to 10, where adequate working capital, long-term employees and customers, consistent growth in revenues and profit, and smooth operations equal a 10.

Many business owners will apply numbers somewhere between a 5 and a 7 to these categories. If you rate your business a 6, for example, this means your company isn’t tapping into 40% of its profit-generating capacity. Consider the level of improvement you would realize by moving up just one notch — to a 7.

Identify areas for improvement

One way to discover your company’s unrealized profit enhancement opportunities is to ask your customers and employees. They know firsthand what you are good at, as well as what needs improvement.

For instance, years ago, when the American auto industry was taking its biggest hits from foreign imports, one of the Big Three manufacturers was experiencing significant customer complaints about poor paint jobs. An upper-level executive visited the paint shop in one of its factories and asked an employee about the source of the problem. The worker replied, “I thought you’d never ask,” and proceeded to explain in detail what was wrong and how to solve it.

Get ready for change

If you have a few New Year’s resolutions in mind but aren’t sure how to implement these ideas or how financially feasible they might be, please contact our firm. We can work with you to identify areas of your business ready for change and help you attain a higher level of success next year.

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Dig Out Your Business Plan to Prepare for the Year Ahead

Like many business owners, you probably created a business plan when you launched your company. But, as is also often the case, you may not have looked at it much since then. Now that fall has arrived and year end is coming soon, why not dig it out? Reviewing and revising a business plan can be a great way to plan for the year ahead.

6 sections to scrutinize

Comprehensive business plans traditionally are composed of six sections. When revisiting yours, look for insights in each one:

1. Executive summary. This should read like an “elevator pitch” regarding your company’s purpose, its financial position and requirements, its state of competitiveness, and its strategic goals. If your business plan is out of date, the executive summary won’t quite jibe with what you do today. Don’t worry: You can rewrite it after you revise the other five sections.

2. Business description. A company’s key features are described here. These include its name, entity type, number of employees, key assets, core competencies, and product or service menu. Look at whether anything has changed and, if so, what. Maybe your workforce has grown or you’ve added products or services.

3. Industry and marketing analysis. This section analyzes the state of a company’s industry and explicates how the business will market itself. Your industry may have changed since your business plan’s original writing. What are the current challenges? Where do opportunities lie? How will you market your company’s strengths to take advantage of these opportunities?

4. Management team description. The business plan needs to recognize the company’s current leadership. Verify the accuracy of who’s identified as an owner and, if necessary, revise the list of management-level employees, providing brief bios of each. As you look over your management team, ask yourself: Are there gaps or weak links? Is one person handling too much?

5. Operational plan. This section explains how a business functions on a day-to-day basis. Scrutinize your operating cycle — that is, the process by which a product or service is delivered to customers and, in turn, how revenue is brought in and expenses are paid. Is it still accurate? The process of revising this description may reveal inefficiencies or redundancies of which you weren’t even aware.

6. Financials. The last section serves as a reasonable estimate of how your company intends to manage its finances in the near future. So, you should review and revise it annually. Key projections to generate are forecasts of your profits and losses, as well as your cash flow, in the coming year. Many business plans also include a balance sheet summarizing current assets, liabilities and equity.

Keep it fresh

The precise structure of business plans can vary but, when regularly revisited, they all have one thing in common: a wealth of up-to-date information about the company described. Don’t leave this valuable document somewhere to gather dust — keep it fresh. Our firm can help you review your business plan and generate accurate financials that allow you to take on the coming year with confidence.  Contact us today!

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December 2018 Tax Deadlines!

  • December 11 — Employees who work for tips
    If you received $20 or more in tips during November, report them to your employer Details
  • December 15 — Corporations
    Deposit the fourth installment of estimated income tax for 2018 Details
  • December 15 — Social security, Medicare, and withheld income tax
    If the monthly deposit rule applies, deposit the tax for payments in November.
  • December 25 — Everyone
    Federal Holiday (Christmas Day) Details
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Fun Fact: How an Accountant Shaped a Major Soft Drink’s Brand

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3 Reasons Why Selling Price isn’t Necessarily a Cash-Equivalent Value

The saying “a bird in the hand is worth two in the bush” rings true when evaluating the time value of money. That is, depending on an investment’s risk and payout period, $1 paid out today could be worth more than $2 promised to be paid far in the future.

How does this concept relate to business valuation? When the value of a business is based on the sales of comparable companies under the guideline merger and acquisition (M&A) method, it’s important to understand the cash-equivalent value of comparables. Creative deal terms can make a deal more (or less) valuable than it appears on the surface. Here are three common reasons why selling price can be a misleading metric and may require an adjustment to arrive at a cash-equivalent value.

  1. Installment contracts

In some situations, the buyer may pay the seller a lump sum up front and then make ongoing installment payments over a period of time (usually, three to five years). These deals sometimes require interest payments, as if the seller is providing financing for the buyer. Other times, the interest rate is wrapped up in the installment payments and can be imputed based on market rates.

Installment contracts are particularly common among small businesses when a shareholder is settling his or her divorce — or when a controlling shareholder is buying out a minority shareholder. Typically, installment sales are used to finance deals when the buyer has limited cash and access to bank loans, possibly due to weak credit, high leverage or insufficient personal assets to guarantee a loan. Here, the seller bears additional risk, because there’s a chance that the buyer may be unable to make timely installment payments.

  1. Earnouts

Likewise, a buyer who’s skeptical of management’s estimates of future earnings may hedge its risk with “earnout” payments. With an earnout, the buyer pays a lump sum down payment, and then the remainder is contingent on the company’s future performance.

The seller may receive the rest of the selling price if certain benchmarks are reached. These benchmarks could include future revenues, market share or cost synergies. Or the seller may opt to receive a set percentage of, say, the company’s gross receipts or net cash flow for a certain number of years.

These provisions can get complicated, so it’s important to define financial terms, payout limits and timing issues upfront. The use of an outside accounting firm can help ensure unbiased financial reporting under U.S. Generally Accepted Accounting Principles (GAAP).

  1. Contractual agreements with sellers

Buyers and sellers may enter into a variety of contractual agreements, including noncompetes, consulting agreements and employment contracts. These may, for example, protect the buyer from competition by the seller (for a specific number of years) or ease the transition from the seller’s management style to the buyer’s style.

Sometimes, these contracts are excluded from the selling prices that are reported in transaction databases. But in other cases, pieces of a deal are bundled together, and the valuation professional must allocate value to each component of the selling price in order to achieve apples-to-apples comparisons. In some industries, however, a noncompete agreement may be standard, and can’t realistically be separated from the selling price.

A need for adjustment

The guideline M&A method has intuitive appeal, because it’s based on real-life transactions. But experienced valuation professionals know better than to blindly accept comparable deals from transaction databases at face value. It’s critical to understand each deal that’s being used as a comparable. Often, “selling price” includes creative deal structures that may require adjustments. For help understanding how this method works, contact a credentialed valuation expert.

 

Sidebar: Bridging the gap

Creative deal structures — such as installment payments, earnouts and contractual provisions — often come in handy when there’s a big difference between the seller’s asking price and the buyer’s offer price. For example, suppose a seller is asking for $10 million, but a buyer thinks the business is worth only $8.5 million. Can the parties work out their 15% difference of opinion?

This hypothetical scenario was worked out with some creative planning. First, the buyer’s valuation expert suggested that the parties could structure the transaction as a stock deal, which worked to the seller’s advantage from a tax perspective, because the seller’s proceeds are generally taxed at the lower long-term capital gains rate.

Then, the seller’s valuation professional recommended an earnout provision to help reduce the risk that the company wouldn’t reach its cash flow projections. If the buyer would pay 65% of the selling price upfront ($6.5 million), the seller would accept the remainder ($3.5 million) over five years. Moreover, the remainder would only be paid on a sliding scale based on whether the company met predetermined revenue benchmarks over the earnout period. No interest would be paid during the earnout period, and the seller agreed to sign a seven-year noncompete agreement.

As a result of these bilateral concessions, the buyer and seller were able to break their deadlock. And they agreed on a creative deal that served the needs of both parties.

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