Getting Working Capital Right is Critical. Here’s How to Do It

Working capital is just a fancy way of saying, “Do you have enough in short-term assets (preferably cash) to cover your short-term liabilities?” Or, stated more bluntly:

-> Can you make the next payroll?
-> Can you make the next check run?
-> Can you pay your suppliers this week?
-> Can you make your next bank payment?

…without borrowing money or adding personal capital. The easier you can cover your short-term cash crunches, the better your working capital position. Usually, businesses with inventory struggle with working capital more. That makes sense. When you buy inventory and hold it, extend credit to your customers, and pay for inventory before collecting, you’ll have working capital pressure.

I’ve struggled with this and figured out why. The way it’s normally analyzed is to ask questions like:

-> How much cash should I have?
-> How much receivables should I have?
-> How much inventory should I have?
-> How much payables should I have?
-> How much sales should I have?
-> How much expenses should I have?

Conventional wisdom says, “what should each account or category be?” Wrong question. Every business has different needs, even those within an industry. You may need to hold more inventory to meet demand or supplier lead time. You may have higher overhead because of a transition or limited automation. You may have seasonality in your sales. Maybe spring is great, and winter is terrible. It makes more sense to calculate working capital needs, compare it to actual working capital, and figure out if you’re in good shape or short. Then you can act.

There is no magic solution, but I found the closest thing to it. It’s called a “Bardahl analysis.” Hat tip to Gary Trugman, CPA/ABV, MCBA, ASA, MVS for providing the Bardahl analysis in his book, Understanding Business Valuation, A Practical Guide to Valuing Small to Medium Sized Businesses.

What Should Working Capital Look Like? Business #1
Let’s look at Business #1. Running it through Bardahl, it looks like this:

They’re not flush with working capital but they have enough. $14,000 is better than negative.

Coming Up Short. Business #2

Here, there’s a significant working capital deficiency of almost $100,000.

What Should You Do if You’re Short?
If you calculate a deficit, it could be one or several issues. Let’s figure this out.

  • Are you holding too much inventory? Maybe you can cut back and still meet demand.
  • Are you collecting from customers? A/R drifting over 30 days is a red flag you aren’t collecting well.
  • Are you taking advantage of terms vendors offer you? If A/P is turning too quickly, you may need to pay less frequently. Don’t be a deadbeat but don’t be silly either. Paying too soon short-circuits your working capital.
  • Are you carrying too much short-term debt? Too much debt due within a short time can pressure working capital.
  • Do you have enough sales for your headcount? Sometimes, you have too many people and the sales per employee doesn’t work.
  • Are your gross margins adequate? Do they stack up in your industry? Low performing gross margins can indicate poor purchasing, too much discounting, or poor pricing.
  • Is your overhead too high? Maybe your non-inventory costs are too high for a business with your level of sales.

Notice that Business #2 had higher operating expenses and A/R and lower A/P. That’s why working capital came up short. Pull one or a few of these levers and you’ll figure out why you’re short working capital. Then you can determine what adjustments you need to make.

The Excel tool is here and it’s free: Working Capital Bardahl

If you’re struggling with the accounting, please let me know if you need help.

Thanks,
Josh

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Can I Help You?
Hi, I’m Josh Horn, CPA, CVA of Horn Valuation. I help with business valuations in friendly or unfriendly situations. I also help owners build valuable companies. My clients are business owners and attorneys. If you’d like more information, check out my website hornvaluation.com, email me at josh@horncpa.com, or call me at 217-649-8794.

Josh Horn CPA

I’m a licensed Certified Public Accountant (CPA) and credentialed in business valuation (CVA). I’ve been a tax and business consultant in a top 100 CPA firm and a controller in a large international company. I’ve also valued and been the primary advisor to multi-million dollar and small companies in various industries.

“If you’re not working on business value, who is?” Josh Horn, CPA and Certified Valuation Analyst

Did You Count Your Inventory?

inventory

Did you know understating your inventory understates income (and vice versa)? If you carry inventory, managing it is no easy task. In fact, I’m amazed how many businesses still rely on the old fashioned “counting” method. Quick Accounting 101 on this. If you understate your inventory, you have more on hand than what your books show. Or, you wrote off inventory that’s still sitting in your warehouse. Put that unrecorded inventory back on your books and income goes up. It’s the opposite when you overstate inventory. You’ll have to write it down to the correct level. Inventory should be recorded at cost.

Who Cares?
This can move your income a lot in either direction if you get it messed up. Let’s say you didn’t update your inventory since the prior year and it showed on your books at $100,000. You forgot to count it and sent in your tax return and bank financial statements. It was $150,000 after the count – short by $50,000 or 50 percent! That also means you understated your income to the IRS and the bank by $50,000 too. That’s double bad but don’t bury your head in the sand. We all make mistakes. Get it corrected and amend the tax returns and financial statements. More importantly, start checking into real-time inventory management systems that will keep you on track.

What Else?
There’s another domino here. This will also impact the value of your business. $50,000, reduced by taxes of 30%, and divided by an estimated 16% rate of return is over $200,000 of “lost” value. Wow, better get this right going forward–especially if you’re buying, selling, or involved in divorce or litigation. Losing $200K is a really bad day.

If you’re struggling with this, hit me back with a message. There’s nothing to be embarrassed about since others are too.

Thanks,
Josh

Sign up for this blog here and connect with me on LinkedInFacebook, and Twitter.

Can I Help You?
Hi, I’m Josh Horn, CPA, CVA of Horn Valuation. I help with business valuations in friendly or unfriendly situations. I also help owners build valuable companies. My clients are business owners and attorneys. If you’d like more information, check out my website hornvaluation.com, email me at josh@horncpa.com, or call me at 217-649-8794.

Josh Horn CPA

I’m a licensed Certified Public Accountant (CPA) and credentialed in business valuation (CVA). I’ve been a tax and business consultant in a top 100 CPA firm and a controller in a large international company. I’ve also valued and been the primary advisor to multi-million dollar and small companies in various industries.

“If you’re not working on business value, who is?” Josh Horn, CPA and Certified Valuation Analyst

Are Those Losses Real? This is How You Find Out

losses

Hey everyone,

Whether you’re running a business or buying one, it’s important to understand losses. By “losses”, I mean when expenses exceed sales. In simplest terms, it’s when the income statement or profit and loss shows a negative number. You don’t need to immediately panic. You need to review the causes.

Here’s my list for non-accountants:
-> Are there personal expenses? (Pull those out).
-> Is it a Tax loss or a Cash loss? (You care about Cash).
-> Cash losses can’t keep going unless more money is invested or borrowed.

Or, stated another way…
-> Is the business worth more “alive than dead?” (Supporting a family without more debt, capital, or fraud).
-> How much cash is going in the owner’s pocket? (Assuming they’re following the rules).

Yes, there’s a lot more I could teach you about accounting if you had the time. But you don’t, so this will put you ahead of 90% of the world.

Thanks,
Josh

Sign up for this blog here and connect with me on LinkedInFacebook, and Twitter.

Can I Help You?

Hi, I’m Josh Horn, CPA, CVA of Horn Valuation. I help with business valuations in friendly or unfriendly situations. I also help owners build valuable companies. My clients are business owners and attorneys. If you’d like more information, check out my website hornvaluation.com, email me at josh@horncpa.com, or call me at 217-649-8794.

Josh Horn CPA

I’m a licensed Certified Public Accountant (CPA) and credentialed in business valuation (CVA). I’ve been a tax and business consultant in a top 100 CPA firm and a controller in a large international company. I’ve also valued and been the primary advisor to multi-million dollar and small companies in various industries.

“If you’re not working on business value, who is?” Josh Horn, CPA and Certified Valuation Analyst

Don’t Gamble with Divorce Tax Returns

gamble

If you’re concerned about using a business tax return for child support, maintenance, and assets in your divorce case, you’re in the right place. It’s a dangerous gamble unless you know what to do. Learn how you can spot the seven red flags and fix them. We begin with a typical business tax return, walk through the red flag adjustments step-by-step, and quantify the impact. You’ll be amazed how much you could be leaving on the table.

The Seven Red Flags of Business Tax Returns guide is here. This is a bullet-point instruction document that defines the seven red flags, provides guidance on why the red flag matters, and gives you detailed steps to fix each red flag. Don’t skip these steps if you’re using a business tax return in divorce.

Secure link to the video here or on YouTube here:

Call me if you would like to discuss valuing a business in divorce or litigation.

Thank you,
Joshua L. Horn, CPA, CVA
Horn Valuation
Phone: 217-649-8794
Email: josh@jhorncpa.com
2901 Boardwalk Dr., Suite A, Champaign, IL 61822

Horn Valuation is for attorneys, judges, and business owners who believe there’s an easier way to settle business disputes and want to work with a valuation expert using fixed fees. I’ve been a CPA since 1999, a certified valuation analyst since 2008, and valued mom and pops to multi-million-dollar businesses. Call me today if you’re interested in working together on a valuation solution.

Not Knowing This Will Cost You Big Time

big time

Recently, I’ve run into some situations where someone was trying to value a business by cobbling the assets together as the only method.  This is Part 1 of a series addressing goodwill in a business.  

Picture a business as a plain old plastic bucket.  And into that bucket, we’re going to pour things like industry expertise, a talented workforce, and maybe some patents or trade secrets.  Then, we’re going to take our “business bucket” and go out into the world and start “watering seeds” and watching the business grow.  Can you see the stuff we put in our bucket?  No, you can’t see it.  Is the bucket much more valuable than the empty piece of plastic we started with?  You bet.  And that’s what goodwill is.  It’s that “invisible stuff” that is not recorded on the business’ books and records but drives a good portion of the business’ value.

Why is this important when valuing a business?

  • A business can easily represent over 90% of a family’s net worth.
  • Unless the business is worth more “dead than alive”, if you value it using only the visible assets, you’ve valued the empty bucket.  You’ve massively undervalued the business and forgot about goodwill.  (Identify)

Why is this important in a family law (divorce) setting when a business is an asset?

  • If the business has goodwill, you may be required to determine how much there is to meet the standards of your jurisdiction. (Quantify)
  • You may then need to split the goodwill into enterprise and personal pieces. Why?  Because enterprise goodwill is marital property and personal goodwill is not marital property in states such as Illinois where I live.  (Allocate)

Business valuation skills and judgement are essential to identify, quantify, and allocate goodwill.  Not knowing how to handle goodwill will cost you big time.

If you’d like to see this concept above on video:  https://goo.gl/y2Q6qA
If you’d like to see a video of how to quantify goodwill:  https://goo.gl/aUds5k
If you’d like to see a video of personal goodwill factors:  https://goo.gl/VhRKVz

Or email me at josh@jhorncpa.com and I’ll send you all 3 video links in secure and downloadable format.  Let me know if you want to talk about goodwill in business valuation or family law.

Call me if you would like to discuss valuing a business in divorce or litigation.

Thanks,
Joshua L. Horn, CPA, CVA
Horn Valuation
Phone: 217-649-8794
Email: josh@jhorncpa.com
Website: hornvaluation.com
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Horn Valuation is for attorneys,  judges, and business owners who believe there’s an easier way to settle business disputes and want to work with a valuation expert using fixed fees. I’ve been a CPA since 1999, a certified valuation analyst since 2008, and valued mom and pops to multi-million-dollar businesses. Call me today if you’re interested in working together on a valuation solution.