Vistage 020818

Vistage 20622 H 1 M

  • Vistage 020818
    • Unlocking Peak Performance, Fiscal Analytics

Unlocking Peak Performance, Fiscal Analytics

2 H 1 M

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Vistage meeting filmed at ITProTV

We have with us today, Mr. Jacobi, who you met telephonically last month. And who is gonna explain in detail the numbers that some of you have in front of you, which are your reports, and how he arrived at them. But you need to know that this guy is just not a numbers cruncher. He has been in entrepreneur. He has started his own company and taken it from zero to 10 million revenue doing a SaaS business. He has the same experience as you do. As well as understanding how you can take the data that comes out of your P and L and balance sheet and help yourself to be a better leader and a better manager. Is that fair enough? >> Thanks. >> And I also have to tell you that the gentleman that he picked to work with him, Dan O'Connell, which some of you saw the e-mails on, and which everybody who got their numbers sent the data to, has got 20 years of Merger and Acquisition experience. So he's also gonna talk to you today about business evaluations. And it isn't business evaluations for your exit strategy as much as it may be, and we've talked about this in one-to-ones, as business acquisitions for your expansion. So without further ado, Roger, it's all yours. >> Good morning, thank you. I feel like I need three hands here cuz I need a clicker, too, and I'm not use to holding a microphone. So before I get started, let me just tell you a little bit about me and why I'm here and how I got involved in this business. As Bill kinda mentioned, I consider myself a serial entrepreneur. The house I grew up in was on the edge of the city, and we literally lived on the city line, and right behind us was this big farmer's field. And as the entrepreneur I was, I went out there and harvested some corn to go out and sell to the neighbors, not realizing there was a difference between feed corn and sweet corn. And my mom got all these calls from the neighbors going where did Roger get this corn that he sold us? So my entrepreneurial roots started very, very early on. I do have an MBA from Michigan in Finance and Marketing. And I've spent much of my career in the medical business, everything from the MRI business at General Electric, so I got to see the real bureaucratic way to do things. And in fact, as I think about it, and I've also been involved in a number of startups. We as entrepreneurs have to become comfortable making decisions with what I call about 60% of the information. If you're a GE, you study it and analyze it and plan it til you get to a 95% confidence interval. You don't want to make a mistake. We as entrepreneurs can't have the luxury of going to 95%. We have to wing it at 60%, and we have to be good enough to read the tea leaves to understand that we're making some really good decisions. We're going to be wrong every now and then, but if we're right most of the time, we're gonna succeed. And what I'm trying to convey to you today is that you have data in front of you that you don't even know is in front of you. And we're gonna go through and really diagnose and look at the financial statements and show you how to get what I call actionable data out of those financial statements. So our goal really here today is to help you have better data to make better decisions. Now, sometimes you're gonna make the same decision anyways, but now you're gonna have a higher confidence interval. So clearly, the other thing I just wanted to mention is we've done many, many analysis, and we run a company a couple of years ago, and I remember looking at the CEO, and it's only happened twice, that we do a very in depth analysis, and I'll cover that in a second, and I got done going through everything and this only happened twice. They were doing everything perfectly, I couldn't help them at all. We couldn't help them in any particular area. And so, I got to the end of the presentation and I turned to the CEO and I said knowing that I haven't been able to give you any insights in how to improve your business, would you hire us again next year to do this analysis? You can expect what I thought to hear for the answer. And the answer was, it's funny cuz he's two years older than me and he looks at me and goes, son, I haven't been called son in a long time. He said son, you just gave me a report card with all A's on it. He says you have just confirmed that the people in this organization are doing exactly what they're supposed to be doing, and they're hitting it out of the ball park. He says, you bet I want you back next year because I wanna know if we slip in any areas, where are those areas so we can get back on track. So as we look at the company we're gonna diagnose today and go through in spades, you're gonna see they're doing many, many, many things right. And what we're trying to find is are there some areas that we can get some insights to that might change the way we're doing our business. And the same things with you. If you get reports back from us that say you're doing fantastic in a particular area, pat yourself on the back, give yourself a high five, whatever it is. Don't take that as I didn't get anything for my money if your investment, because you did get something. You got confirmed you're doing it right. And sometimes, what we do is 80% of the right things, and if we can find that 20% where we can make some improvements, that is the key to improving financial performance. So usually, financial statements are not exactly everybody's favorite thing to talk about. I'm glad you're all here today. One other thing I just wanted to mention is that if you are here as a CFO or a controller for a business, we want to become your best friend. We want to become a resource. Because when I talk to CFOs, they often have a hard time engaging with people that understand and can have a very good conversation back and forth and discuss financial matters. We want to, we recently presented in Seattle, and I turned to one of the CFOs at the end and I said what did you think of the presentation? And her answer was you've now helped me take the information I'm trying to communicate to the organization and put it in terms I can do a better job of doing that. And so, clearly, that's one of the areas we want to focus on. And if you didn't bring your controller or CFO, whatever you do, don't go back and say I found somebody to help you do your job. That will not be received very well, having heard a CEO that tried to do that. Again, our goal is to come alongside and help you succeed in your business. And whatever we can do to do that, that's what we're here for. So without further ado, let me get started and just give you a little bit background and history, who we are as a company, where we came from. Fiscal Advantage has been around since just after the 2008 market crash. Bill mentioned a guy name Dan O'Connell. I can't speak for you in the room, but I know if he was here I would call him the smartest guy in the room just because he has spent 20 years in the MNA business. He has looked at the financial statements of literally thousands of companies. If Dan was here he could tell you all kind of stories of he'd walk into a company and the owner would say it's time for my exit strategy, and Dan would say, well, how much do you think your company is worth? And they owner would say 20 million dollars. Well, Dan would go through the financial statements, he'd look at the market comparables, he'd do the business valuation, he'd come back to the owner and say we might get 15 out of it today on a good day. But if you'd have called me two years ago and we had worked on the key areas of your business, it could be worth $20 million today. So now, you have two choices. You can sell today for 15 million, or we can work together for the next two years, fix these areas of your business, and get the valuation up to where you want it. And story after story after story like that came out, and what he really realized after the 2008 market crash Is that he had a real passion to actually come along side. He enjoyed certainly the transactional part of the M&A business. But what he really enjoyed more was helping small to medium size businesses understand their financials and get better. And so he went and started after that time developing software tools. Because he could take and do the analytics in his head. But to make this cost-effective for small to medium-sized businesses, he needed to be able to take it so the numbers would give him the data he needed to then interpret it for the business. And a lot of time and money was invested over the years in bringing together software tools. So today, if those of you that have supplied this data on your Excel spreadsheet, we literally can copy that data. Do a copy paste into our software, and instantly report prints out. Everything, the verbiage, everything. So, we've mastered and that's how we can do these things very cost effectively for a lot of small businesses. So our core business offering, how we work with businesses. As we literally become what I call the External Financial Analyst, or even a financial coach, our core business strategy is to meet with businesses every quarter for 60 to 90 minutes over the Internet. We go through the prior quarter's financials. Depending on what quarter it is, we may give you a business valuation. If it's in fourth quarter, we often help with budgeting and forecasting. If you're having margin issues, we can dig down. You're gonna see some of the analysis today on margin and cost analysis. And our goal is to equip business owners and their financial people with the tools and the knowledge to better manage their business. Well, we were doing okay. I mean, the problem was we were most often generating this 45 page report. And as CEOs here, you can imagine if someone gave you this wonderfully well-written 45 pages on your financials. By about the third page over the phone I could see the eyes rolling into the back of your heads. It just wasn't communicating cuz we were giving too much information to the wrong person which is why we've changed our model and we're now offering the consult of services. We've taken that 45-page report, broken it into quarterly deliverables. Well, what happened was is there was a company in California called Pacific Advisors. Pacific Advisors is a well known, not on the east coast necessarily yet. Maybe we'll change the name to Atlantic Advisors. Nevermind, and they started using our software capabilities on some of their clients. And it dramatically changed the relationship between Pacific Advisors and their business owner clients. As you can see, they got over 10,000 of them. Because no longer were they walking in and the first things out of their mouth was, can I sell you a tax shelter? I mean, they wouldn't say it that way. Can I sell you a qualified plan? Can I do any of these? No. First thing they're talking about is, coming into a business owner and saying can I help you figure out how to improve cash flow, or improve profitability, or improve the value of your business?. Well clearly that resonated with the business owner so much that they actually acquired our company a little over a year ago. Well now I'm gonna tie this together to Vistage and why we're here. It turns out the CEO of Pacific Advisors is a Vistage member. And in talking to Vistage in his chair and Vistage Corporate, we learned that well over half, probably 75 or 80% of the Vistage chairs across the country struggle in their groups with financial conversations and accountability and metrics and KPIs and all the rest of that. And so we have taken our normal full engagement of a business and we've raised it up to where now we do about 10% of what we normally do. And that's what some of you have already received as part of your two page report. Now at the very end of this presentation, we're gonna go through several of those reports and see what we can garner out of that. I wish Dan were here because he would get about twice as much out of your reports than I'll be able to get to you. But as I've talked to Bill, at an upcoming meeting, Dan will connect in via Skype or something like, then go through the reports with you at a future date. The other thing I just wanted to mention with Pacific Advisors' core business being in tax shelters and things like that. If you ever wanna have one of the principals of that organization back to speak on keeping more of what you earn. In other words, not sending as much money to Washington cuz they're doing such a great job with what we're already sending them. They're well rated on those kinds of topics. So let me go through very quickly, the agenda. Believe it or not, we're gonna spend about 30 minutes dissecting the income statement. Everybody's thrilled on that one, I can see. Then we're gonna spend about 20 minutes on the balance sheet. And we're gonna identify for a particular company where are the greatest opportunities for improvement for this business. We're then gonna take that and we're gonna go into forecasting. And we're gonna say, okay, now we've identified the areas. What happens to this business if we can make some relatively minor improvements in those two areas? What's gonna happen to the business? Then we're gonna have a well deserved break. Then afterwards we're gonna go into business valuations. And I tell you right up front, that's the part where I may get just a little bit into the weeds. Now I've given a version of this talk to the CPA community and other ones and I get way into the weeds. We're not going there, I'm not trying to teach you anything about business valuations other than the basic foundation of what goes into a business valuation. Because if you ever want to either buy or sell a business understanding how the marketplace assesses value to a business I think is critical. Then we're gonna briefly talk about from a lenders perspective, how do banks and credit unions view you as a business owner client?. What do they look at, and how do they judge you? FInally, I'll just talk a little bit about how hard we work with businesses. And then we will have a break, and then we'll go through some of the members' reports that have supplied some data. So I'd like to just start by a basic introduction because the term Fiscal Analytics sometimes scares people, it sounds too technical for them. I'm gonna break it down and make it about as easy as we possibly can. This is the business we're gonna look at today, I'll be handing a hand-out out in just a second. But here's a business that their profit margin is 4.95%, is that good news or bad news? We don't know, we compared to what? Well if I put the company's 3 year trend line, now it's looking pretty good, isn't it? We're all doing great. But before we have the party, when we put the industry numbers up there, we see all we've done in the last years has finally caught up to our industry. So fiscal analytics as you'll see in a second. Looks at a company performance over time in comparison to some benchmarking data. One more quick example, operating expenses as a percentage of sales. That's not a good trend. If your revenue is increasing, the percentage going to operating expenses over time, you would want to become more efficient, more productive. You would want to see that go down. And when I put the industry numbers down, you can see, this is a real area of concern for this particular business. So I'm gonna hand out a handout, as funny as that sounds. So let me start with half over here, and now put half over here. There is enough to go round. So what I want you to do is the first two pages of this other financial statements of the company we're gonna dissect today. There is enough of it, make sure you get all the way round. Now I wanna just take a couple of minutes and I want you to pretend for a moment, this is your company. If this is your company, tell me what the financial statements can tell you. On the left is the income statement, on the right is the balance sheet. Pretend this is your company. What can you get out of this? What observations can you make from the financial statements? And don't everybody speak at once. Okay, what's revenue doing? Sales are going up, isn't it? >> [LAUGH] >> The accountant goes to the balance sheet, I love it. So sales, look at that. We got some great sales increases. Last year, we went up 14%. Almost wanna have a party for the sales team, right? Maybe not quite yet. So what else? Profit margins. Look at that, look at line 12. The operating income's gone up by a million dollars in the last year. Wow, and we kind of just saw that in the graph where we looked at profit margin, finally connecting up to and reaching the industry average. What else? >> [INAUDIBLE] >> The net profit is up, and we're gonna dissect where that profit came from, because that's some really insightful information. How about on the balance sheet? Louise, you were looking at the balance sheet, did you see anything that jumped out at you? >> [INAUDIBLE] >> Cash went up, liabilities went down. Looks like we're doing a great job on the balance sheet. Anything else? So the point I want to make, and is the company we're going to dissect today, is clearly, as we look at our financial statements, there is the income statement and there is the balance sheet. We all have financial statements. What do we, though, as entrepreneurs, what do we want? We don't really want financial statements, what we want is actionable data. We want to know how to read this in a way to make decisions about our business. Fiscal analytics is the bridge. If we use the right analytical techniques, we can get data out of this income statement and balance sheet that you can't believe you are going to learn today. So objectives. I'm going to set ten objectives that we are going to accomplish in the next 2.5 hours. First is we are going to through the income statement. And we're gonna look at profitability. And we're gonna say if we wanted to improve our profitability, what part of the income statement should we focus our efforts on? Number two, still on the income statement, margins. How did our margins really change in the last year? And by the way, you can take notes if you want, and that's why I gave you the handouts. There's other pages there, but I will, a copy the whole slide deck is available to you, so you don't need to try to capture any of that. We're gonna move to the balance sheet. Okay, what is the problem, or are there any areas of the balance sheet that jump out as improving cash flow? And particularly, how much working capital? We're growing our sales, do we have enough working capital to continue going forward? Can we continue to fund the kind of sales increases we already are seeing? What does that look like? Capital expenditures, are we keeping up with our industry, are we keeping up with our own needs? We're going to take a brief look at capital expenditures. Then we're going to go into forecasting and we're going to say if we just look at the next three years and we continue at our current numbers and continue to grow and don't change any thing, what does the future profitability look like for this business? But we're gonna have already identified a couple of variants. One on the income statement and one on the balance sheet. I wanna show you how small changes in key areas have a major impact on the profitability of the business. We're then gonna move in the evaluation phase. What is the business worth today. And clearly, how is business value calculated? We're gonna look at bankability. If we need a loan and we go to the bank, do we qualify for a loan? Can we even get a loan? And taking and putting ourselves for a moment in the shoes of the lender, how does the bank view us? Will they even give us the loan? How do they view our financial performance? So those are the ten objectives. Believe it or not, we're gonna do all that in the next 2.5 hours. If anybody wishes to add to that list, you're welcome to do so. Speak now or forever hold your peace. But hopefully, if we accomplish those 10 things, you'll have a very productive morning. Moving on, I kind of mentioned it's a process, fiscal analytics. We're gonna look at the past, we're gonna look at financial performance, we're gonna identify some specific opportunities for improvement. And then, were going to forecast and show what happens if we make those improvements. It's a fairly simple process, but most businesses don't do anything close to this. So the first thing I want to talk about is industry benchmarks. There'll be some of you that say I don't think the industry benchmarks are relevant to my company. Well, I have two comments on it. First of all, we're running about 90 to 95% of the time, we're finding relevant industry benchmarks. But before I go into that much depth, the ultimate benchmark is your own performance. Has your margin eroded? Has your cash cycle degraded? Have you had any of those issues in your company? Because we're gonna run into what we call classification issues, where some companies are doing something different than their industry. They're putting stuff on the operating expenses that other companies are putting in cost of goods sold. Those aren't gigantic issues, but clearly, when we look at profitability and trends of the company, that's the most important. But we also wanna look at industry benchmarks where they're available, and what we find is that there's a number of sources, you can find some online. The banking industry uses as an organization called RMA, which stands for the Risk Management Association. Now, what happens, whether you know it or not, is your financial statements, if you submit them to your bank, are entered into a nationwide database. Today, that database is over a quarter of a million different companies. And what happens is RMA then compiles that information. And so, if you give them your six digit industry code, they're gonna give you back data for that industry code. Now, they won't give you the data back unless there's at least 100 companies in that cell, because they don't want any one company to either sway the data one way or the other. So we have a license to use that same database. So even if you claim that you don't think the industry benchmarks are relevant to you, if you go have a relationship with the bank, you'd better know what those numbers are, cuz that's what the bank is going to compare you to. The other thing that we do differently that no one else does, and I'm not sure why, is probably 80% of the businesses we work with are becoming more and more complex to the point where a single industry code doesn't describe everything they do in their business. They could have a manufacturing section, and then they could do some distribution, and they might even have a retail outlet. When we look at the combined financials, we're combining three basically very diverse business units. So if you can identify, we allow you to pick up to five different industry codes. So you could say 50% of my revenue comes from the manufacturing, 30% of my revenue comes from the distribution, 20% of my revenue comes from the retail. We'll take those three different codes and we'll use the software to create a combined hybrid industry comparable that's designed to be as close to you as it possibly can. And clearly, we want to get as close. Now, I'll tell you another story, though, is if you have three distinct business units and you have financials on all three units, you're better off running the analysis on each of the three units. We had a situation a couple of years ago, where a company had three different business units. It was convenience stores, a Subway franchise, and a tire store. Three relatively different distinct businesses. First time around, they gave us combined data on the all three entities where it came together at the highest level of the organization. And it looked like they were doing pretty good. I encouraged them to give us data on each three business unit separately. And it was amazing, they learned one of the entities was doing a fantastic job on accounts receivable. One of the other ones was doing awful and when I combined the data, it looked like the organization was doing fine all way around. We had missed the ability to see the opportunity for improvement in that one business segment. So, to the extent you have separate financials, it's often relevant to go ahead and do the analysis on each of the business segments. Because otherwise you can hide particular areas of concern. So let's start our income statement review. Here is the chart for the cost of goods sold for this business. In every one of the slides the company is gonna be the green line. The industry is going to be the red line. That is a wonderful trend for cost of goods sold, it's been decreasing as a percentage of sales every year. It doesn't look like much, but the difference between those two lines represents almost $900,000 of profitability to this business. This is a, as you can see in the financial statements, this is what? A $20 something million company? So they're sitting at 66.9%. The industry, as I recall, was around 71% or 72%. And again, this is the positive trend that we should pat ourselves on the back, give somebody a high five, cuz clearly we're doing great in cost of goods sold. When we get to operating expenses, you kind of saw this graph on the introduction. This is not good news, because our revenues are increasing, but our operating expenses are going up faster. If we could just go back to the same percentage level that we were in 2015, at 24.42%, just going back to where we already were once would improve profitability by over $800,000. Clearly, there's an area here that needs to be dug into deeper. And if we could just even go back to the industry average, it would add over almost over three quarters of a million dollars in profitability. Now, I'll dig into this in a little bit, but I wanna go down a slightly different path at the same time. I wanna introduce you to a concept that we've named unclaimed profit. What is unclaimed profit? Unclaimed profit, I'm gonna define as we go through this analysis here, is basically gonna try to identify, in dollars, how much money have we lost in this case due to margin erosion? That's kind of one way to view it. So if we look at the top level of sales, this next level's cost of goods sold. My best cost of goods sold in the last three years is the current number of 66.9%. My best number of operating expenses was two years ago at 24.4%. So what I wanna just do for the sake of argument is what if, theoretically, I could have achieved both of those highlighted numbers every year? What would it look like if I had, don't tell me we can't attain this, we've already attained it, we've already been there. We've had a slip. So if I look at cost of goods sold, what does it look like if we put 66.9 and, if I look at operating expenses, if we put in 24.4? How does that change? What does that change for the profitability of this business? If I could attain these levels that I've already attained I would drop that base to break even down to 237. What does that mean? Well I look at its variance, the variance is pretty significant. Here is the profitability that was reported on our financial statements. This is what the profitability would have been had I been at those optimal levels each of the last three years. Here's the difference. This is how much money we didn't make because we didn't operate optimally all three years. It's interesting when we look at this as a variance. If you look at most public companies, and certainly not all public companies, but if you look at some public companies this variance because, and I'm not saying that people should go public and and become judged by the whims of Wall Street quarterly performance. But you'll find that most public companies, this number is around 5 to 6, maybe most 10%. The variances that you can have as a business owner are significantly greater but what we wanna talk about is getting to a consistency in performance. Now, I also believe that there's a significant advantage to being in private enterprise, having been there myself, running a company. We can make decisions that we know in the short-term may hurt our profitability, but in the long-term, strategically, are the right things to do. And they don't have to necessarily worry about a bunch of investors who've bought my shares. So, I'm not advocating for that, I'm just saying is, understanding what goes behind the numbers will help you make some better decisions. So if I look now, and ask you a question, if you knew today that your sales in 2018, your revenues, were going to be identical, to the dollar, that they were in 2017. Yet you wanted to increase profitability, how would you do it? >> [INAUDIBLE]. >> What's one of the places? >> [INAUDIBLE]. >> Okay, well, the cost broken down into two sections, operating expenses and cost of goods sold. By definition, if you want to improve your profitability, so if you're taking notes in the handout, profitability comes from three different places. It comes from changes in cost of goods sold, changes in operating expenses, and the margin you're making on those new sales. This is a very simple calculation but I don't know a single business owner that's ever done it. What I wanna do is take this company's profitability. So here, last year, remember we looked at the income statement and we went wow, they're up 14%, they got a $3 million sales increase. And guess what, our operating profit went up by $985,000. As I said, we almost wanna have a party for the sales force but wait for just a minute. What's interesting is when we break it into it's component parts, we can see the cost of goods sold margin, remember that line that's going down, where cost to consult for this business is better every year? That improvement in cost of goods sold added, just from the ratio change, and this chart is in your handout. This changes in cost of goods sold added $1.1 million of profitability all by itself just by the improvement in the ratio change. Remember operating expenses? They're going in the wrong direction. So our increase in ratio change due to operating expenses actually negatively impacted profitability by 230,000. Well if I know those two elements, I can now look and say just because of the changes in ratios, just because of changes in cost of goods sold and operating expenses, I can document $933,000 of change. What that means is my sales increase of 3.1 million only contributed $51,000 in profitability. Kind of not gonna have that party for the sales force quite as quickly as we were gonna have a minute ago. So one of the keys is understanding, where does your profitability come from? Cuz it can come from a number of different areas. Now again, strategically, did this company decide that it wanted to grow sales, and it was willing to discount, and it knew it was getting improvements in the product costs to do it? Possibly, I don't know that for a fact. I'm not trying to say anybody should make a decision strategically but clearly our new sales profitability is not where it should be, in my opinion. In fact, when we look at it as a ratio, the blue line up there is our base sales. In the last two years, our profitability of new sales is down to 1.65%. But our base sales, now the reason the base sales is up so high, particularly in the last year, is that significant improvement in the cost of goods sold. That's being reflected there. So we're looking at the profitability of the base, just over 20 million, versus the incremental 3 million. So we clearly can see that we have an issue with the profitability of our new sales. Now, is that strategically the way we wanna go? I don’t know. We had a another company, I remember, that we did the analysis for. And as we mentioned, my partner Dan is incredibly brilliant. And I remember walking into the meeting with the CEO, and this was in the early days, where we were doing some things, we do a lot of side visits. And Dan sits down and starts the meeting and he looks right at the CEO and he goes, well I've looked at your numbers and it appears to me you're going after a new market. You're discounting to get that new market share. You're giving them improved payment terms, and it's killing your overall profitability. The CEO looks at him and says, how did you know that? And Dan goes, it's right in the numbers. Well, it's this kind of analysis that let's him reach those kinds of conclusions. Cuz, I'm not gonna speak for any of you, I can look at the financial statements all day and I would never see that story behind them. And so clearly what happened with that company is, I know for a fact, cuz she told me after we left, she had a meeting with the VP of Sales. And they were told that their strategy, to go after this new market with discounted and aggressive payment terms, was gonna continue for the rest of that year. But at the end of the year, it had to change, cuz we showed her, as we're gonna get to the forecasting in a bit, what the financial health of the business was gonna look like in a couple of years if this trend continued. And it was an eye opening experience for that CEO. We also calculate something called growth rates, which the green line is just what is the change year over year on the top line of the income statement? That's pretty simple. What that mustard colored line in the middle is, what is the real growth rate? Well, what is the real growth rate? What we do here is that we take out price increases, for one thing, cuz we wanna make sure that we're measuring real growth, not, I increased my price by 5%, so my sales went up by 5%. And we also take out cost of goods sold changes. So if you remember, we had a great improvement in our cost of goods sold. So our real growth rate, really it's more of a growth rate in profitability, is going through the roof. We're also gonna calculate later how much cash flow it takes to grow the sales. That red line is what's called the sustainable growth rate, which is how fast can we grow based on the assets that currently exist in this business. And the good news is, we're not near there yet, we've got some room to grow. We're not gonna need to go to our financial institution anytime soon. We can sustain, in fact, a higher growth rate than even we're on today. So continuing our analysis of the income statement, revenues are going fantastic, 14% compounded annual growth rate over the last three years. Clearly, revenue is not an issue for this business. As we look at operating expenses per employee, we kinda saw this on the operating expenses on the top line, but operating expenses per employee went up 18%, while the business only grew at 14%. That's not a positive trend. We would hope we'd be picking up deficiencies and productivity and being more efficient and that should actually be trending down. So that's not a positive trend. Sales per employee though, that is a very positive trend. We're seeing more productivity in the sales side. So that's a very positive trend for this company. Payroll per employee, normally when we see operating expenses being the problem more times than not it's payroll. We're hiring too many people too fast, whatever it is, but payroll's under control. So we have an operating expense problem. The good news is, we've eliminated payroll as the source of the problem for this business. This is a very positive trend, and driven by you saw that great improvement in cost of goods sold and the big jump in profits. Well, obviously profit for employee is showing a great improvement. And we caught up to the industry average finally on our profitability, which was this chart you saw at the beginning also. Very positive trend, but before we pat ourselves on the back, all we've done is catch up to our industry. We got more work to do. So when i look at the overall income statement, I'm gonna give us a report card. Revenues 14% compounded growth rate, that gets a check mark. Cost of goods sold, best it's been in years, contributed significantly, that gets a check mark. Operating expenses, clearly we have a red flag, something's going on with operating expenses. In fact, this is a real live company, and I will tell you what went on. This is a company who chose over the last two years to invest significantly in the marketing to try to grow the company. And they were just plowing money into everything, trade shows and all kinds of advertising and anything they could throw at. They were trying to grow the revenue line. And clearly, that's a more discretionary expense, and that's something we can hopefully find a way to find a better balance. Cuz I'm not as sure it was all smart money being spent, when we see the profitability on those new sales that we are generating. The profitability of the new sales clearly is also not there. We generated $3 million of new revenue and $50,000 of profitability. That's not a profit margin that's gonna help this company succeed in the long term. The real growth rate, very positive, primarily driven by the improvement in cost of goods sold. Operating expenses to sales, same thing, they're growing faster. It's all back to that same core problem. Sales per employee gets a check mark. Payroll as a percentage of sales absolutely gets a check mark. Profit per employee, that's doing fantastic. Profit margins, best they've been. So this is a report card, if you will, on the income statement. And I'll tell you as an entrepreneur, I never got this kind of information on a regular basis to help make decisions for my business. And that's what this is all about. How can you do that? And you're all still on the financial statements, which is fine. All the formulas and everything are all on here for you. You can calculate every one of these if you want to. It's all there available to you. But clearly, this company, as we go forward, we're gonna look at what happens if we cut back on some of those marketing expenses, and get this under control. What does this mean for the financial health of the business? Any questions at all on the income statement analysis? Nobody, okay, let's move on to the balance sheet. Accounts receivable, the red line, again, is the industry, the green line is the company. We're doing way better than the industry. And knowing the size of this business, the difference in the latest year, in 2017, because we're collecting our receivables what, almost 20 days faster, 15 to 20 days faster. It's actually improving our cash flow by over $1 million more than our industry peers. Accounts receivable is doing fantastic. And as you would expect with that number, that accounts receivable, as your sales go up, You would like to see the percentage that's tied into receivables come down, and that's doing that, it's very positive trend here. We're actually doing better overall, inventory though. Now, I admit I can't figure out would cause a company in from 2015 to go from about 30 days inventory in one year to jump up to 78, and now it's down to 65. The only thing I've been able to surmise, and this is just a conjecture on my part, I don't know this as fact, is they had the opportunity to buy some raw materials at an incredible price. It wasn't something that was going to corrode or get bad with age, and they chose to stock up, and now they're working down that inventory. But whatever it is, this company has a lot of money tied up in inventory. And in fact, the difference between those lines represents almost a half a million dollars of negative cash flow, but it's more tied up in their inventory than their industry benchmark say they should have. So as we look in the future, this is going to be one of those areas we're going to say, what if we can tweak this and improve our amount tied up in inventory even a little bit better. So if we look at inventory here, ideally this should be trending down, but because of that investment or whatever that was two years ago, we are improving now. But inventory to sales, you would hope as your sales go up, the amount of inventory that you need to support those sales is going to come down slightly that you get more efficient in managing your inventory. So the trend last year to this year is fine, but whatever happened two years ago significantly negatively impacted the inventory numbers here. When we look at inventory here to working capital, our goal here is less than one. So clearly whatever that was it we invested in 2016 caused us to jump up, but we are making the improvements in. We are not investing as much new money into inventory. Accounts payable, we have some happy vendors. Maybe, until this last year, we've been paying, the last two years, paying the bills faster than the industry. The last year, we delayed our payments. And that slight difference, as much as that looks like, actually added over $60,000 to cash flow by extending our payables. We can clearly see, as in the current year, we're not paying our bills as fast, looking at payables turnover. Whenever you see the term turnover, it's usually has sales in the denominator. So it's talking about how many turns you have, and this talks to how fast we're paying our bills. There's a concept that is really simple to understand, and it's called the cash conversion cycle or the working capital cycle. And basically, it talks about how long a dollar is employed in the business before it comes back to you. The formula is real simple. It's AR days, accounts receivable, plus inventory days, because those are investments you have, less, you get to subtract from that, payable days, because that's where you have in theory, the interest-free loan from your vendors. So, if we look at this over time and the highlighted area here, we were much higher last year primarily driven by our high inventory, but our total cycle of cash is down to 61-and-a-half days versus the industries at 67. So we are actually managing our cash better than our industry. We can also see that over on the working capital turnover ratio, we're making improvements in turning over our working capital more frequently. Remember the top part of this chart where we talked about and calculated the amount of profitability that came from our sales? I'm gonna now use the same analysis on the cash flow. And again, this chart is in your handout if you're interested. It turns out when we look at receivable days, our receivables are extending. We're not collecting our bills as fast. So looking just at the ratio change, looking at just how much comes from the ratio, our impact on cash flow, just because of receivable days, is at 344,000 negative. But remember, we're using up our inventory. That inventory is coming down. So that improvement in inventory added $880,000 just due to the ratio change in the last year. When we look at payable days, remember we've extended our payable, we're not paying them quite as fast as we did in the past. That actually improved our cash flow by $272,000. So what we can do by totalling these all up is we can say in that ratio change category, that just due to the ratios, the impact on cash flow was $808,000. But when we look at the balance sheet, we see the cash flow actually did change by 290,000. That means that difference is the amount of working capital that we consumed to grow our sales by $3 million. I've not found a CEO yet that when I ask how much capital did it take to grow your sales last year that knew the answer. That's what we're trying to get at is if we want to grow by another $3 million in this next year, and our current numbers continue, we need a little over a half a million dollars to fund that. Really important number, not difficult to calculate, but clearly an important number for all of us to know to grow our businesses. Questions on this table, this analysis? Please. >> Just one observation. When you're talking on the inventory, the inventory days, etc.,one of the things I don't think you have in there is, in some industries, there are [INAUDIBLE] have inventory that is what's good inventory versus bad inventory? [INAUDIBLE] >> Yeah, the comment and it's a very good one is that inventory is one of those things were I can claim and for you inventory that this is the issue, but the problem is that, is it raw materials, work in process, finished goods, obsolescence, pilferage, do we really understand. And for business that deal with inventory, depending on how important it is to the business, if they don't have a sophisticated inventory management system to manage those things and identify those things, clearly that's one of the areas that we often recommend that they have to bite the bullet and get into the 21st century here. Because clearly, if you've got a large business that depends a lot on inventory, managing that whole process can be a significant drain on cash flow, and clearly needs to be better managed. And it's amazing how many times we do have sites recommend they do a physical inventory. And to your point, they have a rather large adjusting entry when they actually do the physical inventory of all the components and see what's really out there, and it's not the same of what's on the books. So inventories on the balance sheet for companies that have to deal with it is one of the more difficult parts of the entire financial statements, so you're a 100% correct. So, but again there is an interesting number that most people don't know. How much cash does it take to grow your sales? So continuing our Balance Sheet Review, now here's a $20 plus million company. The capital expenditures are less than $100,000. Obviously, this is not a business that's dependent on capital investments. But I would also argue that possibly that with the kind of 14% sales growth we're going, we're probably, for whatever reason, not investing significantly, but Even if I double this, it's not gonna have a major impact on the overall financial health of a $20 million company. So even though it technically is an area that I'd look at, given its importance in this particular business, I'm not gonna spend a whole lot of time talking about capital expenditures. >> [INAUDIBLE] >> Absolutely. >> What is your experience as far as the rule of thumb of what you should spend to capitalize each year to keep the business up-to-date? And I've heard all kinds of percentages, but do you have a- >> It dramatically changes from industry to industry. And one of the numbers that we can get that can help this is when we look at something called asset turnover. How effectively are you using your assets to generate the sales? And are you being more efficient? Now, that doesn't always work very well because if you have a massive investment in a new plant or a bunch of really expensive machines that you know are gonna last for 10 or 15 years, the investment may look significant and you're it may take you years to get the productivity out of that. But our company even tells the story of something as simple as computer replacement technology. We're about to go from four years to three years because we couldn't believe the efficiency that people were picking up by finding a faster computer in doing their jobs. And so, it's really an issue of efficiency and how those investments are gonna help grow your company in the profitability over time. But there is no one rule that works for all companies saying you should invest X amount of dollars. Your really have to look at it, and another chart that's up there is the net fixed assets to sales. Are we growing our net fixed assets like we're growing sales? >> [INAUDIBLE] >> No, great comments. So I'm ready for my balance sheet report card. So accounts receivable days, green check mark, we're way better than the industry. We had a little dip from last year, but we're still way better than the industry. We're gonna look at receivables to sales, that is a very positive trend, also. Inventory days, holy cow. We got such inventories, here is tying up a ton of money for this company. Inventory to sales ratio, though, is actually positive. It's coming down as our sales are going up. And we are working that inventory down. Inventory to working capital is good. Our accounts payable days. We've actually stretched them out a little bit and helping get some interest free loans from our vendors. Payables turnover was good. Overall cash conversion cycle, our working capital cycle, that's the best it's been in years. We're better than our industry. That gets a green check mark. And although I'm gonna give capital expenditures a red flag, clearly I'm not going to spend a whole lot of time given the fact that for this business it's just not a significant issue. So as I think about the balance sheet, again, I wanna come back to the concept that us, as entrepreneurs, still have to make good decisions based on data. We had a company recently up in Pennsylvania that we did an analysis for them, and we came to them and we said your accounts receivable days is 123. Your industry is at 90. Both of those numbers are a little crazy. I'm in the medical business. That's what they always are anyways. But for this, this was a clothing manufacturer. And we said do you know why your receivable days are versus the industry 90? That 23 days difference was costing this company 1.2 million in cash flow. We know exactly why. We said okay, could you tell us? And they said, yeah, our largest customer's some little company called Walmart, and Walmart, right on their purchase orders, their payment terms are 120 days. Now, why Walmart needs small business to give them interest free loans, I'm not gonna have that discussion with you here today. But clearly, they strategically chose to do business with Walmart. They needed to make sure they were having sufficient margins. They needed to make sure they had cash on lines at the bank to cover these interest free loans to Walmart. But clearly, that was a strategic decision that they now could monetize and understand the cost of that strategy for their business. So just because we may do a red flag, as I said, if that company made a really smart decision, was able, maybe one of those reasons that cost of goods sold is coming down is cuz they were able to buy key components for the manufacturing and stuff that's not gonna go bad. And that's why they're cost of goods sold. Maybe that was a brilliant decision. But we also need to understand the cash flow implications sometimes of brilliant decisions. Any questions at all in the balance sheet? So we've identified two areas on, let's do some forecasting with some of the things that we've learned. So first, I wanna talk about this company, and if they just held their numbers, if they just took their current numbers and they continued on the path that they're on, what does it look like? And what if we made some changes? We clearly saw that there was some opportunities and operating expenses in Inventory. This is what we call the status quo. This is what is going to happen to this business if nothing changes. At the end of three years, I am just going to focus on the 2020 numbers, this company is going to have an operating Ivid of almost $2 million dollars. We are going to have a cash after operations of 1.5. And even after all our expenditures and capital and everything else, we're still forecasting positive cash flow three years out of over a $1 million. This company could just pat themselves on the back and go home and say, well, what a great job we're doing. But what happens if we make some changes? What impact could we have on this company? I mean, we clearly saw that operating expenses because of those marketing expenses we're going up, and it was really hurting profitability. And our inventory investment needs to be more reasonable. What if we could just tweak both of those? So if I look here, operating expenses, we were at 27.7 % in in the most current year. The industry is at 24, but if you remember, two years ago the company was at 24.4%. Let's just assume we can cut expenses to the point where we can get back to where we were already operating two years ago. And on inventory, we're currently at 64.8 days. The industry is at 54 days. Let's just go kind of almost halfway in-between and let's set our goal for 60 days. I would argue neither of these are going to rock this company terribly to the bone and these should be attainable. Well, what does our future financial health look like if we could just make these two changes? We don't make changes in any other area. What does it look like? Well, here's my status quo numbers. Remember when I looked at operating IBIDTA, I was at about two million? With just those two changes, three years out, I've added a million dollars to that IBIDTA line. When I look at that on a graph, you can see the blue line is where clearly we would like to be with those changes. When I looked at the actual cash surplus, the bottom line, we ended up in the end of the year three with cash surplus of a million, with just those two changes, shaving five days off of inventory, and getting operating expenses back to where they were two years ago. I've added over a million dollars, 1.2 million, to cash flow. What a difference. Those two changes. But I want to stress something here. You're getting the opinion, or should be realizing here, that small changes can have a major impact on the financial health of the business. But this pendulum swings in both directions. We get calls. I've just lost a couple of margin points, and my receivables are only ten days longer than they used to be, and I don't know if I can make payroll next week. And I used to not have a problem at all. As sensitive as these financials are to these two improvements, if I did two things in the other direction, they would have drastic negative impact on this company. And the number, I think, that's fascinating is when we look at the business value. Here we go, we're all interested in this as entrepreneurs and owners. The business value at the end of 2020, if they do nothing and they do the status quo was 12 million. If they make just these two changes, a 50% increase in the value of the business. Knowing where these areas are in your business, and focusing on bringing some changes to key areas, is exactly what this is all about. An amazing change by just those two changes. Any questions before we take a ten-minute break here? Questions from anybody? We've done the income statement, the balance sheet and forecasting, and you're all still awake. All right, ten-minute break. >> All of you at one point or another in one-to-ones, you and I have discussed how do you clearly set goals for your direct reports and your employees? How do you set those goals and have them understand what the impact is? And we've all had the discussion, well, given them a P&L and the balance sheet isn't gonna work. >> [LAUGH] >> That's just [SOUND], they go to sleep. The point of it is, the tools that you're seeing here today, through those sheets and through that calculation in your P&Ls and balance sheets, give you the opportunity to be laser focused about where you want the effort to be. That's the point. So I encourage you to take heart. I know this stuff, excuse me for saying this, can be mind-numbing, okay? You're looking at numbers, [SOUND], but the- >> The people in the back of the room seem to be enjoying it. [LAUGH] >> You notice the CFOs and- >> They're smiling, yeah. >> Yeah. [LAUGH] But the point of it is, from an operational stand point, we've talked about this. We've talked about this face to face and this is an opportunity to take a tool and challenge your employees that if you need to figure out direct report. You need to figure out employee what you can do to impact this number and make it change. Not the whole P&L, but what do you do with inventory? What do you do with where those numbers come out? You see what I'm saying? That's the value in this. Didn't mean to take your [CROSSTALK]. >> No, no, it's okay. And actually, I’m gonna just digress for a minute, because the company I ran for 14 years, as much as we sold for 6 times sales and 14 times earnings, I mean numbers that are just incredible, and we'll discuss that a little bit as we get into the business valuation. I think the thing I'm actually most proud of is in my 12 years before we got bought, we only had one employee leave on their own volition. We certainly let a few go, and that one employee that left knew they were being fired a week later, and they got a chance to quit before I could fire them. I don't enjoy firing, it's the toughest part of any manager, and anybody that's done it knows exactly what I'm talking about. But I think the thing I want to convey to you today is, one of the core abilities that we had, cuz retaining employees once you get them up running and trained is one of the key things to, I think, any businesses success, and that's one of the reasons we succeeded. We struggled because we didn't want to give equity to every employee. That didn't make any sense from a dilution and in many other perspectives having access to the financials. So one of the things we chose to do, and there can be a version of this you could think of, is we had 100% approval from all the owners that we took, every quarter, 5% of the profits derived from the cash flow basis of accounting and distributed it to the ranking file. And we took another 5% and equally divided it to the management team. So every quarter we took cash profits and divided it. And what was amazing is the employees started acting like owners. They were coming in, and they were coming up with ideas on how to improve things. I'd literally go and, hey, paper's on sale at OfficeMax, we should stock up on a couple of cases. I mean, not a big thing, but you could just see the change in the mindset. [COUGH] Now the average employee on the average quarter would receive about $1,500. And again, we had a method where we based it on how long you'd been there, you didn't participate till you'd been there a year. And we did it also on salaries. We capped that, too. It was a rather sophisticated program. But in our third quarter as a company, that was always our down quarter. We were a renewal business, we just didn't have these many renewals in the third quarter. And so the third quarter comes around the first time around. There is no employee bonuses, there's almost a mutiny, not really, they wanna understand the businesses now, why didn't we get our profit sharing check this quarter? And it changed the mindset of the employees. We were also very upfront and frank with our employees that we weren't planning to be in business for the next 100 years, that we were growing this company to a point where we could get the kind of multiples and price that we wanted, and that was the goal. We were upfront from day one, from everyone that was hired. But we took 5% of the cash proceeds on the sale price and divided it up amongst the employees. Any employee that was there more than five years received a payday of $125, when we sold the company and I couldn't have been happier on that day. We literally change lives. So your challenge as an entrepreneur, and I'm not saying my system would work in your company. Is how do you put a system together that changes the mindset from your employees to start thinking like owners? To think about how they can improve the business, how they can grow the revenue, how they can cut the costs? Because you'd be shocked how often, in fact, one of the interesting things we've learned in our consulting side of our business is, we've come alongside businesses. We'll come in and we were talking inventory before, and we'd go into a business and we'd sit down with the people on the manufacturing floor and we'd discuss the inventory problem. And somebody in the back could raise their hand and they say, well, I know what the problem is, but no one will ever listen to me. It's amazing how many times the answers to your problems exist right in the minds of your own employees. You just have to figure out how to get it out of them and create the systems to reward those employees when they start thinking like business owners. And that's what you want them to do. You want every employee to think like a business owner and help you accomplish where you wanna take your businesses. So, little digression there, sorry about that, but I think that's really important. And one of the most important things, when I talk to business owners I want to convey is, if you can find a way to make that mind change in your employees, they become part of the solution instead of part of the problem. In fact, one last point on that, more than once people came to me and said, so-and-so needs to go. I mean, they were the ones coming to me and saying this employee's lacking, they're slacking, they're not doing their fair share, we're having to make up for them. And we don't them bringing us down. I mean, the mind change, if you can accomplish it, is critical to your success. So let's talk about business valuations. Again, as I said at the beginning, business valuations are more of a science. There's a little bit of art in it. There are people out there that are certified business valuation experts, and I don't mean to, in any sense, take away. We're gonna even talk about a couple of things that they do, that they're absolutely qualified to do that we don't do, and we're not qualified to do. And clearly, if you were going to sell your business tomorrow, I would absolutely suggest strongly that you pay your CPA firm, or whomever, to do a certified business valuation. But one of the things we wanna talk about is, if you think about a business evaluation, it's your ultimate report card as a business owner. If there's a way to even tie, maybe executive compensation to improvements in business evaluation, that would be incredible. I'm not saying you can do it. But one of the things that we want you to think about is, if you're making strategic choices and changes to grow your business, on a perfect world, you'd know every year, year over year, how are those decisions you're making affecting the business value of your enterprise. So if it was inexpensive, you might wanna think about having a business valuation done every year and seeing how you tracking over time. So let's start with just a really simple definition from our friends at Wikipedia, who have defined in their definition of a Business Valuation as a process, and a set of procedures to estimate the economic value of an owner's interest in a business. And we're gonna go through and describe those. Not because I want you to learn how to do business valuations. We're not gonna get into the weeds. But clearly if you understand what goes into it, you also understand how to improve it and change it. So as I look at a business valuation, we're gonna do this for three reasons today. Number one, I'm sorry to tell you guys, your businesses probably aren't worth as much as you want to think they are worth. And time, and time, I rarely find a business owner who has a realistic impression of what their business is worth. So clearly, we want to put you on solid footing of what's that worth. But, we also wanna understand what goes into a business evaluation. So, if you wanna improve your value over time, you know how to do it, when you understand the inputs, you'll understand how to do that. And finally, and I was just kinda talking about this, is if you make improvements like we saw that last, this company, if they made those improvements in inventory and operating expenses, in three years we saw their business valuation go from 12 to $18 million. So we wanted to be able to have a baseline that says, if I'm making these changes, if I'm growing my revenue, if I'm improving my profitability, if I'm doing these things, we wanna see how that metric changes over time. We wanna have a base line to compare it to. So, we're gonna go through a definition here. Fair market value and I'm gonna admit to you here, this is the textbook definition, and rarely are all of these things true. But a business evaluation is the value a buyer and seller would agree on, where the economic interest of the buyer and the seller are equal. Now, if you are selling your business, what you want is somebody who views you as a strategic acquisition. The reason we got six and half times revenue for our company and 14 times earnings, was we filled a major hole in their strategic vision. Strategically they needed us to complete their vision. We were worth more to them than we would have been worth to somebody that just wanted to buy us for our business and our profitability. In a perfect world, you want to find people, if you're gonna sell your business someday. Where you strategically, you know, maybe you've locked up the Gainesville market, and this is a market some company really wants to get into, and they've got all the surrounding areas except Gainesville. Strategically, that's a business they want to be in, that means more to them than the financials by themselves, but we can't take that into consideration. Strategic acquisitions add value, but we're gonna talk about where the economic interest is the same for the buyer and the seller. We always have to say everybody has access to complete information, and that's also rarely true. Clearly today, you're gonna learn some of the things to ask if you're thinking about acquiring a company. And if you're selling your company, there might be one or two of those skeletons in the closet that you might not exactly put on the first page of the document that you're giving them. And finally, what we're gonna look at is an ongoing business. We're not looking for a company that's closing its doors, bankruptcy, liquidations, selling the assets. That's not what we're doing today. We're gonna talk about the methodology for actually an ongoing business. So we're gonna go through three different distinct steps. The first and the hardest, and the one we're gonna get in the most into the weeds, and I'm apologizing in advance, is we have to do a bunch of preparations. There are things we're gonna adjust on the financial statements. We've got to calculate rates, we've gotta estimate future earnings. We gotta collect a whole bunch of data, in order to go to step two, where we're gonna take all of that data, and we're gonna apply it to the five most common methods for determining value. And after we've determined that, we want to validate whether or not our value that we've calculated is accurate or not. So, when we look at business valuations, there are several different approaches. And actually if you think about, if you were to go tomorrow and buy a 12 unit apartment building. And you paid a real estate appraiser to appraise the value of the building. They would look at three different things in determining the value. Number one, and the most common is, well, what have other 12 unit apartment buildings in the neighborhood sold for, and I can argue that the market value is probably the most important, and we would agree with that statement. But they'd also look at two other things. They would look at the income producing capability of this asset, and what does the price justify based on what you can get from an income perspective. And the last is cost. If the hurricane came through and leveled it to the ground, what would it cost to rebuilt it, to recreate it? So there's an example in real estate of three very different approaches, used by real estate appraisers, to determine the value of a piece of real estate. The business is very very similar, we're gonna look at an income approach. And when we look at income approaches, there's two forms that are used. One's called the discounted cash flow. Now what that means is we're gonna look at how much money this business would generate going out the next five years, and back to that wonderful statistics course that none of us liked, we're gonna discount that cash flow. Because the dollar, five years from now, isn't worth the same thing as a dollar is today. So that's the discounted cash flow, and of all methods, it's the only method that looks at the future income generation of the entity. So if you're planning very significant changes and increases in your profit ability, it's the only method that's gonna capture this. There is also another method called capitalization of earnings. That is a fairly simple calculation, and because of that, we don't use it heavily. We're gonna use it, but it's only gonna end up comprising about 10% of our evaluation when we're done. There's also the market approaches. What does that mean? That means we're gonna look to the stock market. We're gonna look in the world of how many businesses have been sold. We're gonna look at multiples of EBITDA and earnings. We're also gonna calculate, but not use the multiples of book value or the multiples of equity. And the reason we don't use that is as most small businesses are organized as an LLC or something like that, where they're distributing profits as a pass through organization to its members. And you have to because the tax liability going to the people that own the shares of the company. The book value penalizes you, because it's looking for that value to be up, and up, and up. And so, when you're a C Corp, and you're on the stock market, you don't pay out the dividends anywhere near as much. So because of the nature of small to medium-sized businesses, book value multiples are not usually very accurate. Simply because it penalizes those companies that are paying out their earnings which exactly what we want you to do if you're a Subchapter S or an LLC. Lastly, there's there asset approach that I mentioned where we look at the liquidation value. And clearly, we can't look at that today, we don't know the assets of any particular business. As I said, we're looking at an ongoing business entity. So I also wanna just discuss that there is flexibility in how your value comes out. So if you're planning to pass this on, and the valuation is gonna be to pass on the value to, let's say, your next generation, your kids. You may want a lower valuation. And clearly if you're selling it, and this is funding your retirement, you probably want the highest valuation. Depending what side of the divorce you're on, you may want a high one, or a low one. I was doing a presentation last month out West, and they were going through the divorce. And the wife said, I think the business is worth 15 million. And the husband says, I don't think it's worth quite much. So they paid for the appraisal and it came in at two and a half. She said, you must have picked him, I'm gonna pick my own. So she had her own evaluation done, it was 2.3. So clearly, your valuation ranges can be significantly different but part of it is driven is what is the purpose? What are you doing the valuation for? There is, within legally allowed, some variations based on that to let you pick. Cuz as you're gonna see, the different methods come up with sometimes, including today, some very different values for the business. And where you end up on the lower or the high end of the range can somewhat be driven by the purpose of the valuation that you're doing. So as we're in this prepare phase, where before we actually calculate any values. There's actually four different things that we need to do in this prepare phase. We need to look at four different areas. The first we're gonna look at is adjustments to the income statement. Now, what we want to accomplish here is we want the income statement to represent the true earnings capacity of the business. So to the extent that maybe you've taken a wonderful distribution, and that's great, we encourage that. That's not an operating expense. We're gonna move that out because that wouldn't necessarily we want that to negatively impact. To the extent you may have a luxury box at a sporting event, or an expensive car, or the kids on the payroll, or whatever it is. That a new owner might not choose to do cuz it's not critical to the ongoing business entity. We wanna make adjustments as necessary to the income statement. We also wanna look at adjustments to the balance sheet. The most common adjustment is if you've all done a great job using Section 179 and other depreciations. If you've got a machine in your factory and the book value is $10,000 but you know tomorrow you cold sell it for $50,000. If I buy your business, I'm I getting a $50,000 asset or a $10,000 asset? I'm getting a $50,000 asset. So we're gonna go into the balance sheet and we're gonna say, when you adjust the value of the assets to compensate for to make sure that they're at their true fair market value. That would also be true if the business owned the real estate that it was in. What is the true value of the building if you own it? We're gonna look at something calculating a discount rate. This is the most weeds we're gonna get into today. It is the most controversial thing. We'll discuss it at length. But every company, based on its own risk profile and its industry, has its own unique discount rate. And we'll argue til the cows come home of what that is for your business. I'm not gonna do that today, but we're clearly gonna give you an idea of what goes into calculating a discount rate. And as we have at least one method that's gonna look into the future that we're gonna discount back. We need to estimate what are those future earnings look like for the business? So just real quickly, and I kinda discussed them, our adjustments to the income statement can be in any of these areas. The most common we see is what we call excess compensation. And that means just let's just say, if you sold the business but you could hire somebody to do your job for $200,000, but you're paying yourself $300,000. Then that $100,000 excess should be pulled out because it's not really mandatory to that business. And we're gonna make one simple adjustment to show how that impacts it. In the balance sheet, again, clearly the most often are the assets at fair market values. But we've also seen other companies where they've got a gigantic receivable that's not collected and not going to be collected and it's still in the books and they haven't written it off. Or inventory that we haven't done a physical inventory. We've got obsolescence or theft or all kinds of things. So there can be adjustments to the balance sheet. And there's other kinds of adjustments which are often overlooked and then we'll discuss briefly. One is deliverable working capital, and I'll describe that in a few minutes. But the other's capital expenditures. It's not uncommon to see a business owner say, I'm gonna hold back on capital expenditures for the next two years because I'm gonna sell the business. And what we find is, if you have an educated buyer, they're gonna be able to tell just looking at the history, that you've done that. And if you've cut back expenditures by $500,000, guess what? They're gonna deduct from the value of your business. It's gonna be that $500,000 cuz they're gonna have to put that in to make up for what you've done. We strongly tell owners, run the business like you're gonna be running it for the next 20 years. If you sell it, you sell it. Don't start cutting corners just because you think it's gonna sell. Cuz the statistic of the number of businesses that go up for sale and actually do sale for anything close to what the owner anticipated is a very low number. So here is just a chart that we look at. We were looking at adjustments to the income statement. This is a chart from one of our reports. Again, I'm not trying to teach you all of the potential adjustments that could be made for the sake of this discussion, keeping it on a simplistic level. I'm just gonna say this owner took a distribution of $200,000 a year and we wanna add that back in. Talked about all other kinds of adjustments, we don't need to go into those any more in-depth. So our total adjustments to the income statement as you can see here are simply $200,000. We're gonna now just look the balance sheet. Again, I'm gonna make one simple adjustments so we can show you how this impact things going forward. There could be adjustments in every one of these line items, we have assets that are undervalued by $250,000. We've taking that accelerated depreciation, and we've done a great job with that but the value on the balance sheet is not their true fair market value. So clearly, what we've got here now is adjustments to the balance sheet of $250,000. Just to, again, use this for an example. What is interesting is we can also look at those same benchmarks that we looked at to look at revenues and cost of goods sold, and AR, and all of those other benchmarks where we were looking at all the industry numbers. We can actually calculate what is expected in each of your businesses to be in your business for working capital. So clearly if you look at 2 years ago, if this company sold 2 years ago, their calculation compared to their industry peers is they actually didn't have what they should have in their business for working capital. But partially driven by the incredible profitability in that last year. They right now have $1.7 million more sitting in working capital on their balance sheet than what their industry peers say they should have given their industry and given the revenue of this business. That's important because when we calculate the value of the business which we'll do next. At the end they get to add this 1.7 million to that number. So don't think you have to take out all of the cash at the last minute so that it doesn't go. Because if you know this number you'll get to add it to the business valuation. So here is our Income Statement that we looked at before. It's in your notes. What I'm gonna do is take that $200,000 of adjustments that we just calculated because of the owner's access compensation. I'm bringing it down to that line item, and it's this adjusted EBITDA, this number plus 200,000 that we're gonna use in our calculations going forward. So let's just talk for a minute about the discount rate. The discount rate is, as I kind of mentioned, the most controversial thing that's out there. There is a range of opinions, people like Warren Buffett will tell you. Discount rate should be in 10, 12% and you can find articles where he says that. You can find valuation professionals that say no, any small business is high risk. It should be over 25% and probably, reality is somewhere in the middle there. Well, there are a number of things that go into determining your discount rate. And I haven't highlighted the first three lines because there's nothing you have control over. Those are standard industry metrics of the premium for small business and things like that. You don't have any say. The only one that the industry professional, the evaluation professional that comes to do. One of their key things that they do is they look at your business and they calculate a discount rate. Or what is called here the company-specific risk premium. Well, what does that mean? Well, we're gonna look at, and they're gonna look at concentration of your customer base. If you have one customer that makes up 50% of your revenues, that is more risky obviously than one that has 100 customers that make up the top 50%. We're gonna look at the growth rate of your primary market. If this market is just growing and there's a lot of opportunity, there's less risk for a buyer. If we look at changes in market share. If my industry's growing at 10%, but I'm growing at 20%, I'm obviously taking market share, that's a very positive thing. But if the market's growing at 10% and I'm only growing at 5%, that means I'm doing something wrong, I have more risk. What is my competitive differentiating feature? Do I have a patent? Do I have something that differentiates my product, how do I compete in the marketplace? The more things that you have that allow you to compete will decrease the risk for a potential acquirer. Cyclicality of the industry. If you sell something, I'm just gonna be simple, bread or milk that's gonna be bought no matter what, is going on in the marketplace. You're less risky than you are if you're selling a luxury item that people can easily do without. So these are the kinds of questions, and there's many, many more. We actually have a questionnaire that's, I think, up to 50 different questions that we ask to try to assess the company's specific risk premium. And that is the thing that's gonna vary by company, by industry, by all of these kinds of things and many more. And again, I'm not here to justify the number that we've calculated through the software. But back to my chart, line 29, shows the company's specific risk premium was calculated at 8.82%. Meaning the total, the sum of the four things is 16.37%. What that means is that is the cost of equity. Now, I will tell you that today, particularly in today's market, the cost of debt as you'll see in a second is almost always significantly less than the cost of equity. We were recently working with a company on the West Coast that was looking, and we were actually helping them put the data together for a prospectus. And we calculated that they were gonna end up, not only were they gonna dilute their shares, their cost of equity was almost 50%. Because of the nature of the business, the risk and other things. And clearly, debt, if you can get it was a much, much, much better instrument for this company if they could qualify for the loan. So what we calculated here is what is the expected cost of the equity. But every business, if you have both debt and equity, has also the cost of debt. So we look at the cost of debt for any business we're looking in. And as you can see here, it's basically half for this company. And again these are unique to each company of what is the profile. And what we end up with something is the weighted average cost of capital. So because it's the weighed average, if you have 50% more of your investment in equity, half of it in debt, that's gonna sway the number higher because we're gonna look at the weighted average. How much you have got of each of those? So this particular company's cost is 6. per 7% on equity, 8.15% on debt. But because they don't have much debt, most of their investment capital has been raised through equity. Their weighted average, cost of capital based on their debt structure is 13.9%. 13.9% is what we're gonna use as the discount rate when we calculate the present value of future earnings. We're gonna do a method called the capitalization of earnings method. That is a very simple calculation. We just take the discount rate, less the growth rate but we have to cap that at something and we come up with we're gonna use in our capitalization of earnings method a 6.4%. Again, I'm not trying to teach you how to calculate these, I'm just giving you some level of sophistication that there is some real hard work in science that goes into calculating these rates for any individual business. So the last thing we have to do before we can apply the different methods, is we have to look at the future income stream. And again I'm not trying to turn you into accountants. There is a set process, one goes through when you're looking at revenues and growth rates and EBITDA and we subtract capital expenditures and working capital. And at the end of this process, we end up with something that's called free cash flow. It's also called owner's discretionary cash. So this is the cash that one could expect to pull out of the business in the next five years. And so we're gonna use that in our discounted cash flow method. This is the income stream, or the cash stream, that we're gonna use to discount back to what the value is today. So now I have completed my adjustments to the income statement. We did one for the owner's access compensation, we did the balance sheets bringing our assets up to fair market value. We've calculated a discount and a capitalization rate. We've estimated our future income and you should be thrilled that we are done with the hardest part of the evaluation process. Again I'm not trying to teach you how to do it but I am trying to show you what goes into the components. We're now gonna apply it to the five different methods that are out there, and then we will validate. So, what's interesting, this chart was on the very last slide, this is that free cash flow right in the middle, and I am showing it graphically down in the bottom in the green chart. But what's interesting is not only do we have that free cash flow every one of the next five years that we've calculated, but at the end of five years, guess what? We still have the business, the business is still there. So, in order to calculate the value using what's called the discounted cash flow method, we also have to estimate what the business is gonna be worth in five years. Well, since we've got EBITDA forecasted out here, and we've got market multiples, which will get into in a minute on EBITDA, we're just gonna estimate that the value of this business is $21 million at the end of five years. So, I'm gonna discount this by one year, this by two years, three years, four years, five years, in five years. So that's how I'm going to arrive at this evaluation, is I'm gonna use the discount rate, and take each of those, and discount it back to today's value. And again, not going through the math you'll be very happy to hear, we can calculate using this method, that this business, according to the discounted cash flow method, is worth 15.7 million. One method done. The second one is the one we don't put a lot of credence in. Because there's such a simple formula that looks at the EBITDA, it subtracts some things due to the growth rate, makes another adjustment, divides it by a capitalization when it comes up with a number. Capitalization of earnings is nothing more than taking an earnings calculation, dividing it by the capitalization rate. And what's amazing to me is most of the time, this is the closest I've ever seen the capitalization of earnings estimate compared to the discounted cash flow. They're usually orders of magnitude different. And again, because it's such a simplistic calculation that's base on a capitalization rigth in earnings calculations, we don't use this. When we get to the weighing you'll see this is only weighted a 10%. The third way we look at things is market driven. So what we do is we go and look at your industry code, and we go to the stock market, and we look at companies publicly selling today. What are the multiples in the industry for the equity or book value, multiple of earnings, and multiple of EBITDA. You can see they're listed here. We calculate the value based on the book value, but as I mentioned earlier, we're not gonna use this, because this tends to penalize small companies that distribute their earnings. So we're not gonna look at the equity value of the business. And clearly you can see that it's still consistent with the other ones, but it's not generally one we're gonna use. We're gonna focus on the next two of EBITDA and earnings. Now if I own a share in General Electric, a share of stock and I wanna sell it, I just go down to my trader and I sell it and I have the money in the matter of day or two. If I own a share in any one of your businesses, how fun and easy is it gonna be for me to sell that and liquidate it? It's not, so there is accepted in the market place, a 30% discount based on the lack of liquidity of a share in a private business. So here, our public companies are selling at eight point six multiple of EBITDA, we're gonna take a 30% discount. So the EBITDA we would use, EBITDA multiple for a private company is down to 6.02. There's our EBITDA, and so the value of this business, based on that calculation, is $8.8 million. Doing the same thing for earnings, taking the same 30% discount using the same calculations, this is just over 10 million. And we're just gonna go ahead and combine these two different methods, EBITDA and earnings, into one market value. So this has based on what other companies are selling in the public market, we would estimate this business is worth 9.5 million. Going back at the top, if we looked at what we think the business is worth based on the future cash flows and the future value of the business, it's actually worth fifteen million. This is not uncommon when you apply five different methods to come up with numbers that are Almost double in the different calculations. So, we're gonna rectify those very, very shortly. But let me just cover first and talk about which methods tend to be most accurate given different scenarios. If we have consistent earnings, generally all three come up fairly close. If we have dependable earnings forecasts, same thing. But if we're expecting our future earnings to be significantly different, then by the way you're going to have to convince the buyer of that, but if you can, the discounted cash flow is the only one that looks into the future and tries to put a value on those future earnings. So that one may be the most important, depending on that scenario. High intangible assets, as long as the value of those intangible assets are being reflected in the financials. What I mean is, if you have a patent and you've had that patent for years, we're hoping that the value of that patent Is being reflected in growth of revenue, growth of margins, and the things that would actually, cuz apparently if to be worth something, has to have an impact on the financial health of your business. So if you've got high financial and tangible assets, it should be in the financials. On the other hand, if you just got awarded the patent last week and it's not there, there might be an adjustment that might need to be made for that patent in your financials. An asset rich company, the funny example I always give is that if you owned a drug store on a the corner of Michigan Avenue in downtown Chicago, the real estate would be worth more than the business would be. And so those are the kind of scenarios where it is possible that you might need to look at the asset, because you're not really selling the business, you're selling assets. Liquidation, we're not gonna cover that today. A growth company with some history, if we can project it out, actually that shows that we can get some reliable earnings forecast particularly if the industry is seeing the same growth. And finally, a basic start up without a couple years of financial history is pretty much relegated to the asset approach at this point. So, basically we're looking at an ongoing business, which is why we look at the discounted cash flow, the capitalization of earnings, and the selling multiples. >> [INAUDIBLE] >> Absolutely. >> So when you're looking at forcasting the earnings, how much distinction will you make between what you would expect that company to do under the current owner versus what you expect you will be able to do? Maybe you have economies of scale, maybe you have more efficiencies. >> Well again, you can be on either side. The question was how does the earnings forecast, versus what the company is currently doing today to what a new company could do with that. New owner would do with that, I understand. That gets in the part of that strategic thing I was talking about earlier, where I as the buyer know what I can do with that, and so I'm gonna be running those calculations on my own. And I'm gonna know what this business is worth to me because of the value I see I can bring to it. And that can be growth and revenue, but it also can be cost savings. A lot of people buy things and know how much cost I can structure out of that. If I'm the seller, though, it's hard for me to estimate that. And so what I'm gonna look at, is what is it as today, but I'm gonna know strategically that this new owner has the ability to either grow the revenue or cut the costs or improve the profitability. So I'm not going to go for any less than what the calculations show. I'm probably going to demand somewhat of a premium, but it's really difficult for the seller to know exactly what the buyer is thinking as far as increased revenue or decreased cost to make that happen. >> [INAUDIBLE] Seller change his mind about [INAUDIBLE]. >> Yeah, but I'm gonna base the value on what would it be worth to me if I continue as a on-going operation. And anything I get above that I would consider a good thing. So anyway, we've done the preparation. That was the hard part. We whipped through cuz its pretty straight forward once we have all the data to calculate the different methods. And now we're gonna take it for a minute and talk about how do we actually calculate, did the value we came up with make any sense. So when I look at the value I've calculated, what we've talked about is the capitalization of earnings method. We hold as one of the least reliable methods. So as you can see, the weighting there. The middle column is we're gonna weight that at 10%. There are many people that believe the discounted cash flow should count more than the other methods. But we struggle with that because just like real estate, the value of the building is what it's selling for today in the marketplace. So we're going to actually weight the discounted cash flow at 30%. And although it says 60% for the market value, remember that's made up of two different numbers. That's made up the ibida multiple and the earnings multple. So you could argue that the discounted cash flow ibida and earnings are all weighted at the same 30%, and again that's our opinion of what we do. These are the ones areas where you can get evaluation professional to have a different opinion, if you want. So this is what we get for the weighted average of the different evaluation methods. We're saying this business according to our calculations is worth just under $12 million. But remember we get to add to that, the $250,000 in the asset value that we had didn't add in yet. And for some strange reasons that buyer wants to us to pay off our long term debt. That's generally an expectation at the closing of business. So this is actually the value of the equity going to the business owner. So we just take a plus or minus 10% on that middle line up there, that 12.2 million, and we give a range. Because again, this is almost as much an art as it is a science. You can see the science that goes into the numbers. But again the different numbers here say there also has to be some art to what we're doing. And let's not forget that we get to add that 1.7 million in excess working capital that we calculated to the value of the business. We get that cash in the cash account. So this is an interesting chart because if I'm the buyer, I'm really liking the multiple vividend, that's what I want to pay for you business. If I'm the seller, gee, I think the discounted cash flow is the most accurate because I got a good future ahead of me. What's reality? Somewhere in between. And you can have an opinion on which one. We're gonna validate this in a minute and we're gonna determine, I'm telling you right now, I'm giving you the last chapter of the story, that in fact the discount in casual is closer to the value of this business than the market value methods are. But we don't know that yet. We now are just using our fair market value over their 12.2 million as the number we're gonna move forward. So how do we validate that number? How do we determine if that's an appropriate number? Well we're going to take that $12 million and we're going to go through a fictitious sale. We're going to assume we are going to go sell the business tomorrow. Well if we assume that, we're gonna have to make some assumptions. And clearly those assumptions vary widely when we look at some transactions, we usually see some debt and some equity in an acquisition. Obviously if you are being acquired by a big giant, they're just gonna write you a check. But as far as validation, we're gonna do a scenario where we assume a buyer comes in, pays 30% down, finances 70%. And we're gonna calculate what does the buyer earn as a return on their equity. We're gonna kinda use that as a judge on how good our evaluation is. Well we calculate, and again, I can walk you all the way through it, this buyer's gonna get a 57 annual return on their equity. Well, let me tell you, if this is a company you're acquiring, sign those papers today. If you're the seller, you're gonna go back to that range and you're gonna be at the top into the range, you're gonna be looking more towards the discounted cashflow. But again, you have to remember business evaluations are just as important whether you're buying or selling. So we calculated here is we're little light on our evaluation that our valuation number actually needs to come up. And that's the reason you go through a validation process. So we've looked at it. We did all those tough numbers on the preparation. We applied it to the five different methods. We've actually validated and in this case our valuation was a little light. But we certainly have the justification now to take it up. And we have other numbers that we can use. And that pretty much wraps up the business valuation. Nobody's asleep, that's a good thing? Luis loved it, and maybe even some of my other accounting professionals here loved it. Questions, comments, thoughts, please, yes. >> For this example, was it just the industry that you were dealing with, [INAUDIBLE] 7.5%, where'd that 7.5% come from? >> Again, that's one of those things. It's more of an art than a science, because if we took the real growth rate of this company at 14%, we would have a negative captailization rate and the company would have been worth an infinite amount of dollars. So the reasoning behind that is there aren't many companies, now maybe small companies can grow percentage wise faster. But clearly, most companies on a revenue or a profit side, growing consistently year over year by more than 7.5% is actually difficult to sustain. Obviously, when you're in a real small company, and you're making, you can grow a lot faster than that. But when I think of a company of this size, of 20 to 25 million growing year, over year, over year, having my growth rate of profits be more than 7.5% is pretty difficult to sustain. And so we'll put a cap on that for that very reason. You may have a one year spike where you can do that. But to sustain 14% year over year is just not realistic for most businesses. Any other questions, comments on the business valuation? Yeah, go. >> If it's too complicated to explain in depth, why are you adding the distribution back into the formula? And if you've taken them out, you reduce the value of the company. >> Good, no, I'm glad you asked. The question is why do we add the distributions back in. The answer is, the distributions are not part of the operating profit. Those would be classified as non-operating expenses. We think of operating expenses, we're talking about what it takes to operate the business. And what we want the income statement to be is a reflection of the earnings potential of the business. Since distributions are discretionary you can choose or choose not to do the distribution. That's why we take those out and you're welcome to comment, Louise, and help me out here. >> Well, there's a base consumption there that distributions aren't on the income statement which is not where accountants put them. We put them on the balance sheet, so you just have to know that. >> Yeah, Louise is right. What we are making sure is, if you did put them on the income statement we wanna back them out because they should not impact the valuation of the underlying business profitability. Cuz that's a discretionary expense. This year we need the cash, we're not gonna do any distributions. Well, if you did that for three years does the value of the business go up? Technically not because what you're talking about is the ability of the business to generate profits. How you choose to distribute those profits shouldn't affect the valuation. Great question, thank you. Any other questions? Please, yes Bill? >> Is there one aspect of the calculations or one type of calculation that was more for acquiring versus selling? >> The question was, is there a better method for acquiring versus selling. And the answer's no, because I've seen the calculations where the discounted cash flow is the lowest number. And clearly what we're trying to get here by using the different methods, since the different methods look at different things, we wanna see the range and the different values. Now, to your point, you could choose to weight them differently depending on what side of the transaction you're on. If you're the seller, you wanna weight the higher values more, and again, you can play with these numbers you want. The goal here again is not to teach you how to do a business evaluation. The goal here is for you to understand just like in real estate the answer is location, location, location, in business evaluation it's operating profit, operating profit, operating profit. If you have the got the EBITDA, if you've got the earnings that will result in free cash flow and distributions to the owners that's what a new buyer wants to buy. They wanna buy something that when they buy it's gonna generate and pay them back cash. And so improving the profitability, improving the cash flow drives the business value. >> Can you share example of these calculations connecting back to what we did before the break? >> Well, what we talked about, in fact, if you remember the very last slide before we broke, was if they made that change in inventory of five days and improved the operating expenses back to where they were two years ago. Those two changes took this company from the status quo if they didn't make the changes, in three years was worth 12 million. By making those changes, because it improved the EBITDA and the cash flow, we were able to calculate that the value of this business three years later would be 18 million instead of 12 million, 50% increase. So, clearly managing our businesses in a way that drives profitability is what is going to drive the value of the business. Go ahead, no, I'm glad you're asking, >> So I'm sure in the math or formula somewhere there's gotta be a return on the equity factored into this whole thing. I didn't hear lot of information, so I'm trying to digest it all. I didn't hear where there's someone calculating what the return on equity is, to determine the value of projections. >> Well, the return, actually we did at the very end when we validated whether or not we had the right price. What I looked at was, what the return on a new buyers equity. What it was there return on their equity in that transaction to do. So we did look at the return and equity as part of validating the concept of the price that we've calculated. But the actual methodologies that are used to calculate value do not take that into consideration in calculating the value. Cuz the return in equity is a calculation, it is the return divided by equity. It is a ratio, if you will, based on numbers. Now you can say as a buyer or a seller, I'm looking to get a particular return on equity. And you can use that as a judgement factor of whether or not your gonna sell or not sell, or buy or not buy based on a thing. But it's not calculation that used in any of the standard methodologies. But again, think how different you gonna think of it there's a company out there that you wanna acquire. Or if you thinking of that exit event in the future to financial your retirement or whatever. You now have a whole different way of looking at things and maybe you did an hour ago when you came in here and that's the goal here today. Any other questions or comments? >> I've got one. >> Go Bill. >> It looks to me, we of course talked about how everybody remembering at some point what they need to do to increase the value of their company. And through the process of analyzing the, of the balanced sheet, but the reverse of that is also true. If you, in the purchasing process or acquiring process, if you've analyze PNL on a balance sheet, you can spot the same kind of opportunities for purchasing at this price and increasing the value of. >> Yeah, no, no, the questions was basically that in the first half we talked about improving the financial performance, and relating that to business value. And you're exactly correct, if you're a smart acquirer, you will do the front half of this evaluation. Cuz you're gonna go and say, okay, I see where those efficiencies that we were just talking about, the duplication of efforts. I can see it, I don't need to spend as much marketing, I can see, I can bring inventories, you're gonna see. Let me put it differently, if I'm the acquirer and I see this business is absolutely stellar, it's hitting it out of the ballpark of all areas. My opportunity to make changes to improve profitability are much less. I would rather find a company where I do that front ended analysis and I see where those holes are. I see where I can make improvements, and now I know once I acquire this company, where to make those changes to make improvements in the financial. Now that companies worth more to me because I know how I can drive the value of that business by making some of improvements in those other areas. I personally wouldn't buy a company without doing, not only the business valuation, but the front end, to know where this companies operating compared to its metrics. And I probably wouldn't share it with the company I was buying, so, [LAUGH] >> [LAUGH] >> I wanna have that data in my quiver. Yes, sir? >> Question, on the adjustments, if you have a heavy say, marketing department, and you have a heavy home office department, where you know the potential sellers because you're selling them to a specific market or a are larger big chain type things. They won't have those, as a seller, should you add those back into the calculation, also? >> The question is, if you know the your potential acquirer is gonna bring efficiencies of scale, do you take those calculations into account when you're doing the business valuation? And the answer is you can, but selling that to them on the valuation is gonna be really tough because that's one of the reasons they're doing this. Cuz they're seeing strategically and financially why it makes sense for them. But clearly, if you know that they're going to get all kinds of additional reductions in the cost structure that are gonna improve profitability. That certainly again says, I'm not gonna settle for anything less than this, whatever that is. Because I know they're gonna be able to improve the profitability. But that is part of their thinking on their side is the value of why they're acquiring you. You can't take all that value out of the transaction and still expect them to buy that. Because then there's no reason for them financially, sometimes to go forward with the transaction. Yes? >> In all of your research I'm assuming that you can, getting out of the industry, get a general feel for what that multiplier ought to be. >> Yes. >> You have a general idea of what value to market. >> Well, we looked to the marketplace and we got specific, the question was on the multiples. And clearly what we need to do and what we do in every industry is we go to the market and get as close as we can to the five or six digit industry code to find public selling multiples. And we don't pick the extremes, the great performers, or the ones that are not doing well. We tried to pick middle of the road companies and we picked several of those and we averaged them. So, when we go to the, use the market multiples for book value, EBIT, and earnings, we're looking for public companies. But you're right, those multiples are very different industry to industry based on the different industry characteristics. And our belief is, is that the stock market is an efficient system in determining what the worth and the value is of different industries. So we use companies in that industry to come up with those multiples that we use in all of our calculations. >> Industry benchmarks for, like that don't even go to the service industries in particularly, like in our business, where it's really just a multiplier of gross. >> Yeah and the question was, there are service industries and other companies where they may not have these same metrics. And there are certain, if you had a dental practice, there's generally accepted dental practice multiples. And the multiples change based on how much of the revenue is coming from Medicaid versus private pay versus whatever. And if you have more than 50% Medicaid, then the value's gonna be this multiple, and if it's less than 20% Medicaid, it's going to. So yes, there are service industries in particular that have different metrics that look at those and then you also again look at that strategic part of it. But clearly there are those specific industries that have multipliers outside of the standard. If we're done on evaluation, I'm just gonna spend a couple of minutes, this is a fairly high-level overview on what we call the lender's perspective. So, you may have questions, if you're a lender, if you're looking like it of what are the up coming cash needs of the business? Clearly we saw this business, we've looked at today is generating cash like an ATM. They're not gonna need to go to their bank, that's okay. But that doesn't describe most businesses. And we also saw how this company was consuming over a half million dollars in cash to grow their revenues, in this case by three million. That's an okay number, they can handle that. But not every business is like that. If the company does need to go to the bank, how much collateral does the company have to put up? Now, there's the hard asset collateral, and there are some banks that will also loan based on multiples of dividend, other kinds of calculations like that. There are also certain metrics that a bank or a lender looks at to qualify someone for a loan. And we also wanna briefly talk about how the lender, putting yourself in the lender's shoes for a second, how do they look at you as an entity? So here's my same company looking at my status quo, and I've calculated by 20, I think I got the wrong chart because this only goes to 2018, looks at a one point million at revenue. I think the data is right, but the years at the top are somehow wrong. And we look at the credit capacity of this business again, business has no issue from it's ability to get a loan. One of the very, very, very key numbers in yesterdays presentation we had banker and he was giving thumbs up is something they call the debt service coverage ratio. Now, what this simply means is, after this loan is in place, does the business radically have this ability to pay the loan back. I know that it's really strange that they want their money back, but do they have the ability? So, the minimum as it says here is 1.25, so what that says is it looks at your earnings. After the loan payment is in there, and is there at least 25% margin in it. Can you pay it back and still have a 25% margin left over? A debt service coverage ratio just says, can you cover the debt that you are signing up for. Now, this business is way above the 1.25 minimum, the bank yesterday said their number is 1.3, but that's okay. That's still in the range there, but this company is over 3 already, really don't need to worry about that. Most companies, it's not uncommon, we see come in 0.9, 0.95, they're not gonna get the loan. But then remember, we went ahead and changed the status quo. We made some improvements in operating expenses and inventory. And again, here's the status quo. And I know this company doesn't need it, but I wanna show that by making those exact same changes we looked at before, we see a dramatic improvement in the debt-service coverage ratio. So we companies all the time that today don't qualify for a loan, but if this was that company and they made improvement in operating expenses and inventory. Very quickly, the numbers are gonna improve significantly enough to where that debt-service coverage ration, now meets the minimum of the lending institution. And again, very dramatic changes from very small changes in the business. And I'm gonna remind you one more time, this pendulum swings both ways. You can think you're doing great today and have a debt service coverage ratio of one and half. And you think you're doing great, and your margin slips by a couple of points, and your cash cycle gets extended. And all of a sudden, without even you realizing it you dip below that number and you might not even make your loan covenants anymore. This pendulum is very, very sensitive. The last slide I have here basically when we talk to lenders they look and they're doing an analysis and I mentioned early on the database that they use is from a company called RMA, the Risk Management Association. They actually do in their underwriting department, they're looking at a whole v bunch of different metrics. And part of what we wanna make you aware is even if you don't think those benchmarks apply to you, in the mind of your lender, they apply to you. So you better know what they are. So here's some sample of the most common metrics that we see used by financial institutions. And we love turning things into ratios and numbers and scorecards. So we look at the business and what they've done over the last three years. We look at the industry average and you can see after each one of those on the left-hand side, we weight them differently. We come up with a rating and again, I'm not gonna walk you all the way through this, and we do a score at the bottom. So an average company with score six. This company scores 7.78. All that says is that compared to their industry peers, they are operating on all of their financial matrix on average well above their industry peers. This is a loan that the bank would love to write. If you are down in the 5 range, and the industry is at 6, you are gonna have to come in with a really good explanation on why you are different from the matrix. Why those metrics don't apply or why you can argue over them because their warning bells will be going off as they wanna do the under writing. So when we started here a couple hours ago, we talked about ten different objectives and I just wanna review those. We looked at the income statement. And for this particular company we really recognized their ability and need to focus on reducing their operating expenses to improve their profitability. And we looked at the margins. We saw that the margins on the new sales clearly were not where we thought they should be. $3 million in new sales, they generated just over $50,000 of net income. Something's going on and maybe it's the discounting, maybe the price needs to go up. I'm not sure what it is, but clearly there 's something there that needs a little bit more work. We looked at cash flow and we've determined that our inventory level was significantly above our industry. That if we needed to improve cash flow we needed to bring the inventory down to the industry standards. We looked at sales. We learned that it took a little over a half a million dollars in cash flow to fund sales. We now can estimate our working capital requirements going forward as a business. We looked briefly at capital expenditures. Turns out wasn't a major issue for this business, but clearly we wanna make sure that asset turnover and utilization in some of those areas are clearly being looked at and managed by the business. We looked at the future. The future actually looked really bright, had over a million dollars of positive cash spun off in the next year. It was gonna be great, but we also saw we could more than double that million to 2. million if we just reduced our operating expenses and reduced our inventory level. We saw what the business is worth today. It was interesting, we calculated it at $2.2 million evaluation. We learned what goes into making up a business valuation. We also learned as we validated it that that in this particular instance, we needed to be a little bit higher than the valuation was calculated. We looked at bankability. We looked at this particular company, tthey clearly have the borrowing capacity and have the financial strength to do it. But we also looked at it from the lenders perspective. We looked at all of the different loan covenants and the different metrics that they're gonna judge the bankability of this business.

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