About Ned Armstrong

Ned Armstrong has been a member since July 27th 2014, and has created 61 posts from scratch.

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Focus on Costs and Funding Growth — February 2018

This post involves financial management. The vast majority of businesses need to closely monitor and proactively manage operating expenses. This process enables the firm to attain profitability and remain competitive. Insights gained from the analysis of operating expenses will inform the CFO as to whether action is required or if the company may need to incur additional expenses in the future. Control of operating expenses is among the CFO’s most important duties, as this effort is crucial to the company’s survival. In addition, by being prepared to spend more to fund growth opportunities, the CFO helps contribute to the firm’s growth.
Operating expenses are the costs incurred, other than the cost of the production, to run a business. These expenses, also known as selling, general, and administrative (SG&A) expenses, include the cost of selling, marketing, accounting, finance, order entry, risk management, and corporate overhead. Expenses can be classified by the function or the nature of the expense. The former aggregates expenses by department (i.e. research & development department), whereas the latter is characterized by the use of the cash expenditure (i.e. salary expense).
We believe the best way to analyze operating expenses is through horizontal analysis. This method entails a comparison of historical expenses over a series of reporting periods, with the intent of investigating spikes and drops in specific periods. In addition, the CFO should look for long term trends in expense items.
Once the trends are discerned, the CFO must determine if they match the company’s strategy. For instance, a company focused on new products may have high research and development expenses relative to marketing expenses. On the other hand, a business that sells a mature product is likely to emphasize service or customization. Accordingly, the marketing expense may be quite large compared to the product development expense.
Operating expenses tend to be relatively fixed within a range of sales. This enables the CFO to identify expense trends and take appropriate action. This can be in the form of expense reduction or determination of the point in the future additional expenses need to be incurred. We suggest these actions be pursued in conjunction with the appropriate operating and executive management.
The vast majority of businesses need to closely monitor and proactively manage operating expenses. This process enables the firm to attain profitability and remain competitive. Insights gained from the analysis of operating expenses will inform the CFO as to whether action is required or if the company may need to incur additional expenses in the future. Control of operating expenses is among the CFO’s most important duties, as this effort is crucial to the company’s survival. In addition, by being prepared to spend more to fund growth opportunities, the CFO helps contribute to the firm’s growth.
Capitol CFO Solutions serves clients in Washington D. C., Maryland, and Virginia. Please contact us for a free consultation.

Watch Those Costs Like a Hawk – January 2018

This post involves financial reporting.
A key aspect of financial reporting involves providing important information regarding costs to the appropriate internal and external personnel. The CFO is instrumental for oversight of this function. The cost accounting department is the major activity center for providing this important information. By driving this function, the CFO provides operating managers insights that can be used to pursue the most profitable products and services; streamline expenses; and pursue the optimal use of resources. In addition, there are a series of responsibilities to the firm’s management reporting and financial reporting efforts.
In many organizations there is an unending series of requests from operating management and executive management to provide information regarding many topics. One is an analysis of capital spending proposals. Often, this effort involves providing insight on large spending proposals by management. Topics addressed include, reasonableness of forecasts, whether the expenditure improves bottleneck operations, and whether all expenses that may be incurred are included in the documentation.
Customer performance is another area where the cost accounting department can provide clarity. Of particular importance (and helpfulness) is profit by customer, but also customer backlog, customer returns, and discounts granted to a particular customer.
The cost accounting function can also be used in the analysis of prior decisions. This effort generally involves whether the assumptions to make the decision were accurate as well as what circumstances caused changes in the original forecasts.
Cost accounting can also be utilized to track cost trends for key inputs, particularly commodities as well as other cost centers. In addition, key metrics critical to the firm’s performance can be tracked, investigated, and explained. Finally, various profitability factors can be tracked and analyzed. These factors include profitability by department, job, or product; a single product; and a particular product line.
A key element in the foregoing items is that the internal reporting is not constrained by promulgated accounting principles. Thus, a specific approach analyzing the economic consequences of management’s actions can be utilized.
From the financial reporting perspective, the most important of cost accounting is the determination of ending inventory. This, in turn, is instrumental in the determination of the firm’s gross margin and overall profitability.

A key aspect of financial reporting involves providing important information regarding costs to the appropriate internal and external personnel. The CFO is instrumental for oversight of this function. The cost accounting department is the major activity center for providing this important information. By driving this function, the CFO provides operating managers insights that can be used to pursue the most profitable products and services; streamline expenses; and pursue the optimal use of resources. In addition, there are a series of responsibilities to the firm’s management reporting and financial reporting efforts.
Capitol CFO Solutions serves clients in Washington, D.C., Maryland, and Virginia. Please contact us for a free consultation.

Getting the Price Right – December 2017

This post involves valuation. When a firm pursues an acquisition, it must determine the price it is willing to pay for the target company. Typically, this process begins with the valuation of the target’s common stock. While the CEO and Board of Directors make the final decision, the CFO is instrumental in providing the appropriate methodology for determining that value.
We recommend that the CFO utilize a discounted cash flow methodology. This entails forecasting the target’s cash flow based on past performance and expectations for the future. Factors from past performance include profit margins, asset efficiency, capital structure and sales growth (adjusted for acquisitions and divestitures made by the target company). Factors for the future expectations include expected future sales growth including benefits to sales due to being part of the acquiring company, future margin expansion including cost savings, capital structure requirements, working capital requirements along with potential improvements in the efficiency thereof, and capital investments needed to maintain competitiveness as well as fund growth opportunities.
The cash flows that need to be calculated and discounted are calculated as follows:
• Net Operating Profit After Taxes (NOPAT), plus
• Depreciation and Amortization, less
• Working Capital Requirements, less
• Capital Spending Requirements
NOPAT is defined as the pretax profits before interest multiplied by 1 minus the effective tax rate. This exercise removes the tax benefits derived from the interest paid on debt. It shows the value of the target as if it had no leverage, in our opinion a cleaner view of the value of the target’s prowess as an operating business.
Once the cash flows for future years are determined, they should be discounted back at the cost of equity. This value can be difficult to determine for a small, private company. We suggest a rate of between 15% and 25% which ultimately represents the required return on investment as ultimately determined by the CEO and Board of Directors based on their assessment of the risks involved. It considers such factors as size, industry dynamics, risks in product markets, competitive risks, and regulatory risks among others.
We recommend a time frame of ten years along with a terminal value at the end of year 10. The terminal value is calculated as the cash flow from year 10 divided by the discount rate minus the long term growth rate. The resulting value is discounted to the present at the discount rate.
Once the value is determined, it must be adjusted for several factors relevant to the target company. These factors include:
• Transfer limitations on stock ownership
• Buy/Sell Agreements
• Dilution due to warrants stock options, and convertible securities
• Other classes of stock, notably preferred stock
• Lease obligations
• Obligations to repurchase shares upon death or termination
• Repayment or assumption of debt obligations.
These factors will typically be negotiated by the respective CEO’s and Boards of Directors. If debt is assumed, the tax value (due to deductibility) of the interest payments should be added to the value of the target. If the debt is to be retired, the face value of the debt must be added as a price adjustment. Depending on the legalities of the other factors, additional price adjustments may be necessary.
Once all of this is accomplished, the valuation is compared against rule of thumb measures such as PE ratio, Total Capitalization to Sales, Total Capitalization to EBITDA, and Price to Book Value (for certain types of industries). These ratios should be compared to industry standards or public company multiples adapted to the target company’s size. Material discrepancies must be reconciled.
When a firm pursues an acquisition, it must determine the price it is willing to pay for the target company. Typically, this process begins with the valuation of the target’s common stock. While the CEO and Board of Directors make the final decision, the CFO is instrumental in providing the appropriate methodology of determining that value.
Capitol CFO Solutions serves clients in Washington D.C., Maryland, and Virginia. Please contact us for a free consultation

Effective Cash Systems – November 2017

This post involves Treasury. A critical duty of the CFO is to devise and operate a cash system. A well designed cash system is essential to effective cash management. A good cash system allows the CFO to anticipate cash needs and focus on working capital management – the key to an effective cash system. When determining working capital needs we recommend the use of the cash conversion cycle as the main management tool.
Using the cash conversion cycle lets the CFO know how many days must be funded with non-working capital sources such as bank credit lines. The measure is calculated as days in receivables plus days in inventory less days in payables. If the result of the calculation is, say, 80 days then the CFO will need to utilize all or part of the firm’s bank credit facility over that period.
Effective use of the bank line of credit will enable the CFO to provide operating cash, source emergency cash, minimize idle cash, invest excess cash, and control cash assets. The key means of achieving these goals entails accelerating collections and slowing disbursements. An important tool for doing so is the use of lock box operations and controlled disbursements.
Lock box operations entail a set up whereby payments are sent to a lock box at a bank rather than directly to the company. The bank retrieves and credits the account (via software) several times daily. The detail of what has occurred during the day is remitted to the company. The major benefit of lock box operations are that they eliminate internal float and post office processing, thereby making the cash collection effort quicker and more cost effective. That said, increased use of electronic payments has reduced, but not eliminated, this advantage particularly for small businesses that have customers who do not use advanced check writing technologies.
Controlled disbursements utilize a zero balance account whereby check clearing patterns are analyzed. Based on the analysis, a banking location is selected that will maximize the time required to clear checks. This location is driven by the company’s location, the bank network, and vendor location. While this methodology has been made quicker due to electronic banking, many small businesses can still use electronic check writing to create paper checks.
These strategies will help and be helped by the firm’s other efforts in cash management and liquidity management. Key functions in cash management include:
• Cash forecasting
• Working capital management
• Cash concentration
• Debt compliance
• Bank relations
Important liquidity management functions include:
• Cash reserve requirements
• Sufficient cash on hand for payment of bills
• Tracking Cash
• Compliance with contractually mandated cash balances
This post involves Treasury. A critical duty of the CFO is to devise and operate a cash system. A well designed cash system is essential to effective cash management. A good cash system allows the CFO to anticipate cash needs and focus on working capital management – the key to an effective cash system. When determining working capital needs we recommend the use of the cash conversion cycle as the main management tool.
Capitol CFO Solutions serves clients in Washington, D.C., Maryland, and Virginia. Please contact us for a free consultation.

Keeping Management in the Loop – October 2017

This post regards Financial Reporting. Projects are a necessary part of many business arrangements. A project can be defined as producing unique output rather than an ongoing stream of goods and services and has a definable starting point and ending point. Some examples of projects include R&D efforts, new buildings, an upgraded website, creating a new billing system, and a special order for a key client. We believe it is wise for the CFO to develop project specific billing, costing, and reporting systems.
When management decides to undertake a new project, the CFO or an employee is designated by the CFO to be the project accountant. This person is responsible for monitoring the progress of the project, investigating variances, ensuring the client is billed on a timely basis, and timely collection of amounts due on invoices issued. This responsibility consists of several specific tasks in the following areas:
• Records Management
• Expense Oversight
• Customer Billings
• Management Reporting
• Outside Party Reporting
Record management entails creating the appropriate accounts in a project-specific accounting system. In addition to assuring that correct entries are made, general records should be maintained. Such records include items like contracts, change orders, and documentation of expenses. The CFO or a designated representative is empowered to oversee access to project accounts and authorize expenses to the accounts. At the completion of the project, the CFO ensures that the project accounts are closed out and integrated into the firm’s general accounting records.
Expense oversight involves approval of all expenditures, time sheets, and overhead allocation related to the project. Moreover, the CFO should analyze and investigate reasons for variances relative to expectations and budgets. If necessary, corrective actions should be pursued. Finally, unpaid contract billings must be investigated and resolved.
Customer billings is a function that requires persistent oversight. Key tasks include creating or approving project related billings to customers; investigation of project costs not billed to customers; and the write off of billings to customers that are deemed unbillable or uncollectible.
Management reporting is crucial in keeping the CEO and other executives informed about the project’s progress. Executive management should be able to access information regarding the project’s profitability as well as an explanation of variances from financial and operational targets. In addition, management should be informed of opportunities to initiate additional bills to customers. Finally, it is critical that executive management be aware of the remaining funding available for the project.
In some instances, it may be necessary to report to outside parties on matters regarding a project. Such parties include independent Board members, customers, government entities, lenders, and auditors. It is up to the CFO to provide information that is both comprehensive and germane to the interests of such outside parties.
Projects are a necessary part of many business arrangements. A project can be defined as producing unique output rather than an ongoing stream of goods and services and has a definable starting point and ending point. Some examples of projects include R&D efforts, new buildings, an upgraded website, creating a new billing system, and a special order for a key client. We believe it is wise for the CFO to develop project specific billing, costing, and reporting systems.
Capitol CFO Solutions serves clients in Washington, D.C., Maryland, and Virginia. Please contact us for a free consultation