Banking on our uncertainty

In an story that caught about a ten second blurb this week on Friday morning, the Federal Reserve is working on a plan to not only monitor pay compensation but also one that will allow the Fed to adjust or change the pay practices at Wall Street financial firms. Not just firms that accepted bailout funds, but any financial firm that the Fed deems necessary based upon the firm's excessive risk-taking practices. Also note that the language does not simply limit the pay for executives at the firm. It has the right to limit the pay to anyone that works at the firm according to a Wall Street Journal report.

Excuse me, comrade?

Where does one begin in an attempt to shoot holes in this idea?

Perhaps the easiest target is the Federal Reserve itself. You know the group, right? The same group that sets interest rates in order to manipulate the economy, avoiding recessions, inflation, speculative practices, steering the U.S. to continued economic prosperity and ensure that banks continue to lend to businesses and indivuals that deserve a loan. How's that working so far, Mr. Bernake?

Maybe it's better to look at the Fed based upon the past. The same history that gave former Treasury Secretary Hank Paulson a blank check to bailout Wall Street firms (of which I was critical, I might add.) The same history that kept interest rates artificially low for too long in order to allow the gluttonous behavior to continue. The same history that took budget surpluses at the end of the 1990's to a whopping $11 trillion debt. Again I ask, how's that working?

Consider the impact of keeping overnight rates at 0% (not a typo) since December of last year and no sign that they are going up anytime soon, and then asking a banker to not take some risk with 'free' money. Oh yeah, while you're at, throw in the fact that the Fed is asking banks to make loans to get the economy rolling.

Oh, maybe I'm being too harsh.

Surely there's some good, right?

Ah yes, the same Federal Reserve that has partnered with ACORN since 1977 to enforce bank compliance with the Community Reinvestment Act. In mortgage land, CRA loans (as they are called) are also known as 'subprime' mortgage loans to folks that generally would not qualify for a home based upon credit or ability to repay. How's that working?

To be fair, I hate the banks. Ask any of my students, and they will tell you the adjectives I use to describe most bankers are "lazy, fat and boring. And lazy. Did I mention lazy?"

But to be true to my roots, I also believe in capitalism, entrepreneurial spirit and the corporate structure. If a publicly traded bank like, oh I dunno, Bank of America, wants to make loans it thinks will perform and reward shareholders, shouldn't they be allowed to do that? After all, it's their job to maximize shareholder wealth - not anyone else's wealth. SHAREHOLDER wealth. If the shareholders think the CEO and board are doing a lousy job by taking too much risk with too little potential return, they can (and often will) fire the CEO and replace the board.

Similarly, if the U.S. government wants to get into the banking business, they have two ready-made platforms to execute that plan while remaining outside the circle of overseeing pay for private firms. Maybe the names Fannie Mae and Freddie Mac ring a bell in your head. If the Fed wants to be in banking, turn Fannie and her brother Freddie into large national banks that are required to adhere to strict compensation, risk and corporate management guidelines. Make them play by the same liquidity rules as the other banks and let all of the banks duke it out. Guess who will win, comrades? Yep. You, me and cousin Vinny due to increased competition and a level playing field.

What's next? Will the Fed determine it's their job to monitor and adjust the pay for professional athletes? Does Big Ben really deserve $110 million to throw a football? After all, he's taking a LOT of risk going out there against 330 pound men eager to rip him to shreds. Maybe they will think that doctors should only earn "X" per year regardless of their specialty, or that accountants cannot earn more than "Y." The system is already in place around the country in the form of government pay scales and in many instances labor-contracts, which primarily exist between governments and their employees, the exceptions being large unions like the auto-workers, mine workers, steel workers, etc.

Farfetched? We already have a minimum wage. Doesn't it stand to reason there could be a maximum wage? And while we are accustom to having a minimum wage to assist those with few valuable skills and protect workers from abuse, how does it feel knowing the shoe could be on the other foot, limiting your skills and placing a maximum value on what you have to offer? It's not as crazy as it sounds, folks. And it's happening and a rapid pace.

I'm not in the predicting business, but here's one for ya.

There are going to be three very large national banks in the next three to five years that are entirely government run. Their names are Bank of American, Chase and Citigroup. They will be merged and monitored by Fannie Mae and Freddie Mac, who will report directly to the Federal Reserve Board. The Federal Reserve Board is going to become a fourth branch of government.

Hold onto your wallet and get out your voter card to make sure it's still either Republican, Democrat, Independent and not Socialist or Communist.

Takin' care of business

Have you hit the skids yet? After all, the kids are back at school, school buses are clogging up the highways and nights are getting longer. Sometimes just for kicks my wife and I will hang out on the porch when it gets dark early and pretend that it's still summer. It's not, of course, but pretending is fun.

Pretending is not fun, however, when a business is at risk of making game-changing mistakes.

A business owner recently called me and asked for my evaluation of their current cashflows so I rolled up my sleeves and dug into some antiquated spreadsheets about customers, an unaudited profit and loss statement and an unaudited balance sheet. If those three things sound sorta, you know, casual, it's because they are. In short, it's like keeping your checkbook balance on a paper napkin or a grocery receipt.

Regardless, I did my best and came to the conclusion that only about 30% of the business promised to him by his customers actually resulted in a sale, yet the staff had to go through about 80% of the promised business. They were spending a ton of time working on potential sales that would never transpire, as history showed that the customer-base failed to deliver most of the time. Of course, there were a few notable exceptions, which I pointed out in my moderately formal report back to the client. The staff was frustrated because they felt like they were working too hard and too long. And they were correct. Unfortunately the company was not profiting from their efforts.

Upon delivering the report, I followed-up with a phone call and a lengthy discussion in order to point out some significant cost saving measures. The culmination of the call came when I suggested something radical - eliminating over half of his customers and focusing on the remaining customers that could deliver promised sales on a fairly regular basis. A final suggestion was to perhaps remove one or more of the positions that served the customers since there would be far fewer potential sales to screen in order to get to an actual sale.

To say I was pleased with my findings, both quantitative and qualitative, would be an understatement.

"Christian, I see your point but I'm thinking of adding staff so that we can hit the break-even point," was his response.

(Crickets chirping here, please.)

"Chris, are you there?"

It's as if my hard data and suggestions weren't even heard or acknowledged, and in fact, I was living in opposite world. I had suggested firing clients and staff, focusing on the core business and streamlining things - not taking on additional payroll, headaches and a bigger nut to crack.

Pretending is not a good option if you are a business owner. In fact, it's not a good option for anyone (unless you are a girl pretending to be a fairy princess or a kid that wants to throw the winning touchdown pass in the Super Bowl.)

But we all pretend, don't we? We pretend that a relationship that has been horrible for twenty years is going to change, or that a job we hate will change once the economy turns around or perhaps a child/loved one that has been a hell-raiser will finally come around.

In relationships we call this 'vested,' or in poker we call it 'pot-committed.' In short it means that emotionally it's too hard to remove ourselves and it seems the only logical thing to to is see it through the (already known)outcome.

As a business owner, it's imperative to never become enamored with an idea that stops working or your 'baby.' Focus on the bottom line and once it goes to red, get out immediately.

GM, Chrysler, National Record Mart, Asbestos, Polaroid One Shots, typewriters and carbon copies were all great ideas too. Now they are all either firmly planted along the landing strip of business progress or approaching quickly. Sometimes (most times) technology impedes our ability to keep doing the same thing and make the same profits. The runway is covered with failed landing attempts.

Recognize when the business changes and prepare to make drastic changes to meet the challenge, or prepare to close shop. Those are the only alternatives in business, and in life, actually.

I have a friend that says "if I have to kiss a frog, I kiss the frog and move on."

I urge each of you to find the frogs remaining in your life, kiss them goodbye and move on. Only princesses get to kiss frogs and have them turn into a Prince.

Labor of love

Happy Labor Day folks. The deliberate writing and delivery of this blog indicates that while I appreciate the day off, I probably don't need it right now. After all, the kids have been in school exactly one week, I've been working exactly three weeks and football season hasn't even started so there's no reason to need a Monday off right now. But I digress.

At the risk of becoming one of those nasty, right-winged, hatred filled, venomous fear-mongers, however, I think a few minutes should be spent on just how much it costs to run a business before we simply kick back enjoy a cold beer and some potato chips this afternoon sticking it to 'the man.'

First and foremost, please remember that 'the man' is risking everything so that others can have a job; one that supports a family, pays a mortgage, puts new wheels on the minivan, braces on little Suzie and maybe even creates memories from Disney World or the beach each summer. According the the Small Business Administration, 80% of the businesses in the U.S. are classified as small businesses as well, so we're not talking Enron, MCI, AIG (fill in the blank of your favorite dirtball CEO here.) We're talking middle class America - machine shops, pizza shops, lawn care, funeral homes and small industrial companies.

Now on to the financial facts.

In the U.S. we have a progressive tax, which is accountant-speak for "the more you make the more you pay." We also have something called a marginal tax rate, which is any amount above a certain limit but not as high as the next bracket. For corporations this total tax rate can be as low as 15% on the first $50,000 of taxable income to as high as 39% on income of $100,000. This is tax corporations pay at the federal level.

Naturally states want their take, too. The national average state income tax is about 6.5%, but we don't like to be average here in Pennsylvania. As a result, corporations in the Keystone State pay 9.9% corporate income tax. To be fair, a portion of the federal income tax can be eliminated when a company pays the state taxes, but according to the Tax Foundation, in 2008 Pennsylvania corporations paid a combined effective tax rate of nearly 42%, second only to Iowa. This is 3.5% more than a company in Japan, by the way, and a full 4% less than a company located in Germany and 6% more than a company in Canada (aren't they supposed to be taxed higher than us?)

Okay. So you're not good with percentages. I am, though. These figures show that if you have a company in Pennsylvania that has $100,000 in taxable income the CEO takes home (drumroll please).... a whopping $58,000!

The really great thing is that the corporate owners, also known as shareholders, get to pay taxes on their dividends too! This is called double-taxation if you're keeping score at home.

So let's go back to 'the man' and see how he's feeling right now. By the way, he (or she, to be fair) is probably only taking part of the day off since there is work to be done, payroll to process, paperwork to file or orders to be filled. Is it worth the risk to own a business, putting your personal livelihood, your kids future, your spouse's trust, on the line so that others can argue over personal days, vacation time, call in when it snows, etc.? I don't know.

According to CNN employers lost about $900 million in lost revenue during March Madness as a result of employees trolling the Internet to catch up on scores, fill in brackets, etc. Lost revenue is even higher for fantasy football.

It's enough to make me tired and need a day off. Hey, wait. That's what Labor Day is for!

Health care reform

Let me be the first to admit that I seldom, if ever, need my employer-sponsored healthcare package. I'm probably one of the lucky ones. I'm also not a doctor (and I've never played one on TV) so I don't know the total story when it comes to billing, paying, services, wait times in emergency rooms, elective surgeries, etc.

With that said, however, I understand business, finance and people...in that order.

So it's no surprise that business people despise the new healthcare reform package offered up by the government. And to be fair, who can blame them? The current tax system already imposes 15-35% income tax on businesses, and individual states throw more on top. Mix in 7.5% taxes into the social security fund, 1.65% into unemployment on the first $7,000 earned by each employee and most businesses can fairly say they pay upwards of 45% to the government. That's a lot of money, particularly on small business owners, which make up 80% of all employers in the US according to the Small Business Administration. If you owned a business that made $100,000 per year before taxes, how would you feel if you only took home $55,000 -$60,000 per year and were being asked to pay more?

Not sure about you, but I'd hire fewer people and actually consider firing a few, too. That doesn't sit too well ever, but especially now given our current 9.5% (reported) unemployment.

On the finance side, the system stinks worse than the Pittsburgh Pirate's front office (maybe) and there's no end in sight. How can an insurance company charge one fee, accept another from the healthcare provider and not be held to better standards? While I fully support price discrimination, as most economists would (if you don't know what price discrimination is, think "Ladies night" or "kids eat free" or the way the airlines price tickets and you'll understand the concept) health insurance price discrimination makes no sense whatsoever from a financial point of view. The pricing scheme is so convoluted that I actually do know why things cost so differently from one provider to the next - they don't know how to price their product or service.

People. Now this is a different story entirely.

Shame on us. We know better, yet we continue to try and get something for nothing or ask for more support so that we don't need to modify our behavior that lead to the problem! Rather than asking Uncle Sam to come up with a solution, maybe it makes more sense to modify our diets, exercise more, smoke less and eat more veggies so that we don't need to go to the doctor's office as often. If we go less, the demand for the product goes down and providers would need to find a better method to attract our business, such as, oh I don't know.... LOWER COSTS?

Ah, the "preventive" maintenance argument. That one hurts the most, as it actually involves personal responsibility, but it makes the most sense.

Think about it. If fewer of us needed to go to the doctor's office, emergency room, surgeons, etc. because our bodies were better equipped and healthier, those needing services would have quicker access, less tired healthcare providers and insurance companies that weren't questioning everything?

I'd love to call it innovative, but it's as old as the hills.

So consider my healthcare reform today by reforming your old habits. Take a walk, turn off the television and put down that bag of chips.

Finding the Perfect Balance

Okay, I confess.

This is a misleading title intended to draw in you readers that are opposed to doing hard numbers and would rather focus on the soft sciences of psychology, marketing, etc.

Gotcha!

The perfect balance I am referring to is the Balance Sheet. This simple, usually one-page document gives a snapshot of any given business at one point in time - typically at the end of the month of a business quarter/cycle.

The beauty with the balance sheet, though, is that while tiny in size, it is a magnifying glass to everything goin on within the business itself.

Remember, the left side has to equal the right side! As a result, the assets (left side) are equal to liabilities (debt) + capital (owner's equity.) Whew. That was hard.

Take a look at the one below:

Weeklybusinesstips

June 8, 2008

Assets Liabilities

Cash $50,000 Short-term Debt $30,000

Accounts Rec $40,000 Accounts Payable $50,000

Merchandies/ Salaries $110,000

Inventory $100,000 Total Current Liabilities $190,000

Total Current

Assets $190,000 Long-term Debt $20,000

Plant/Equip $30,000

Accumulated

Depreciation (2000) Owner Equity $8000

Total Assets $218,000 Total Liability/Equity $218,000

Yes, I know it's exciting to read a balance sheet on a blog; especially one as basic as this. But the ramifications from the balance sheet are enormous, and our understanding of the business grows tremendously once we begin to dig into the balance sheet and discover that things exist there.

First, and foremost, is notice that the assets are listed from most liquid to least liquid.

Why is this the case?

As business owners, I don't need to tell you that cash is king. It's the most easily understood, and universally accepted, forms of payment. You don't need to process anything more than a receipt and the corresponding deposit slip, as the bank accepts these funds the instant they hit your account.

Account receivable, on the other hand, are from your credit paying customers. Aside from the credit card comany taking their 2-3.5% fee on each transaction from you, there is always the risk of the purchase being disputed by the customer, and the processing time takes a few more days. Thus, AR is not as liquid as cash.

Finally, inventory is listed as a current asset and considered the least liquid. This is the result of fluctuations in the business cycle and an ever-changing consumer demand for your product. Additionally, your accounting method will need to be considered for the balance sheet, as the price you paid two weeks ago to make your product may be higher or lower than when you purchased the materials. FIFO and LIFO are important elements to consider for this entry.

On the liability side, the same science is applied, using short term debts and accounts payable as the most necessary payments, followed by longer-term liabilities.

So you don't need to be a rocket scientist to realize that if you reduce your liabilities, a.k.a. - costs, expenditures, debts, etc. and your assets stay the same, your owners equity has to increase in order to balance the account! That's why costs are so important with what we do.

Imagine how great this balance sheet would improve if we simply cut our accounts payable by 20% to a total of $40,000. The owners equity would increase from $8000 to $18,000! And that doesn't even factor the possibility of increasing cash balances with increased sales or higher prices.

A few final thoughts on the balance sheet.

1. It is not wise to skip over a balance sheet. While elementary in scope, that is intentional. The balance sheet is intended to be the glossary for accompanying financial statements such as the income statement, statement of cash flows, profit and loss statement, etc.

2. The balance sheet is a snapshot of one day in time! Keep it consistent and monitor your balance sheet frequently. If not daily, at least weekly, and make it the same time each week. For instance if you have large sales on the weekend, get a Monday morning balance sheet.

3. Pay attention to variables within your business that fall into categories that can jeopardize your equity position on the balance sheet, such as accounts receivable and accounts payable. While it might increase sales in the short-run, relaxing credit standards to sell more items is seldom a wise move for the long-haul. Similarly, review your vendor accounts frequently and push for better terms as your performance paying the accounts improve. For example, you may have a perfect record paying within 30 days to all of your vendors. Go back and ask for a reduced bill if you pay in full within 15 or 20 days, such as a 2/15 net 30 (this means a 2% reduced bill if you pay it within 15 days, or just full payment if you pay after 15 but before 30 days.) Most vendors will work with you so long as your credit history with them is positive.

4. Don't dwell over the numbers! It's too easy to become bogged down and get frustrated when things don't turn your way on the balance sheet. We will later discuss how to improve cash flows, so just be cognizant of your balance sheets and find ways to make minor modifications to your business process that result in increased cash balances, reduced inventories and lower costs.

Please send your questions and/or comments to me anytime! I'd love to know that you're reading and enjoying.