PCO Business Financial Statement Basics
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Transcript of PCO Business Financial Statement Basics
THE PEST CONTROL INDUSTRY’S MOST TRUSTED ACCOUNTING FIRM
PCOBOOKKEEPERS
PCO Business Financial
Statement Basics
By: Daniel S. Gordon, CPA
THE PEST CONTROL INDUSTRY’S MOST TRUSTED ACCOUNTING FIRM
PCOBOOKKEEPERS
Intro To Cash or Accrual…..That Is the
Question
Financial Statement Basics
How does A Banker Look at Your Financials
Games People Play
How does a potential Purchaser or Equity Partner Look at Your
Financials
A word about getting money out of the
company – The Good the Bad and the Ugly
Case Study
Putting It All Together
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Introduction
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Remember a Time When Business Was Easy?
We Got A Call
Took Care of the
Customer’s Problem
Made a Profit for Doing so.
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Remember a Time When Business Was Easy?
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Then we decided to grow our Business. In growing we recognized the fact that we have stakeholders. These stakeholders need to be fed information. Who are these Stakeholders?
Stakeholders
Outsiders
The Bank
Taxing Authorities
Vendors
Prospective Purchasers of Our Business
InsidersThe Folks
Running Our Companies
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We Are Entrepreneurs; Not AccountantsObservation: The Most Successful Businesses
have a leader who is…A Great Marketer
A Motivator of People
Knowledgeable about The Product or Service They Offer
Can Deliver That Product or Service in an Efficient Manner
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Notice we didn’t say a business leader needs to be a great accountant. However, there is a requirement for a growing Business:
A trusted member of the Leadership needs to be intimately involved with Accounting. He must be able to access the quality of the accounting data compiled and he must be able to interpret a financial statement.
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On the Subject of Accounting Data:
On the Subject of GIGO:
“You can put Lipstick on a Pig, It’s still a Pig.” – Barack Obama
“Paper accepts all Ink” – Anonymous
This Information and presentation must be in accordance with a consistent method of accounting
Any Accounting System can produce Financials – What’s under the hood?
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To Accrue, or not to Accrue…..That is the Question
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The most widely used methods of Accounting for small business:
Modified Accrual
Accrual
Cash
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Cash
The cash method is simple in that the business's books are kept based on the actual flow of cash in and out of the business • Income is recorded when it's received, and expenses are
reported when they're actually paid
• From a tax standpoint, it's sometimes advantageous for a business to use the cash method of accounting
• That way, recording income can be put off until the next tax year,
while expenses are counted right away
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Accrual
Revenues are recognized when they are earned rather than when the cash is received. The balance sheet is also affected at the time revenues are earned as opposed to collected by:
Either an increase in Cash (if the service or sale was for cash)
An increase in Accounts Receivable (if the service was performed on credit); or
A decrease in Unearned Revenues (if the service was performed after the customer had paid in advance for the service).
Expenses are recorded when they are incurred as opposed to when they are paid creating Accounts Payable on the Balance Sheet
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Modified Accrual
A method mainly to accommodate timing of reporting such that we don’t have to wait for documents thereby delaying the closing process
While accruals can be made for these items, many times it’s worth it to record certain items when they arrive and as long as the item is recorded at least monthly, over time the accrual based income is relatively close
The most important idea here is that the information is consistently recorded period to period.
Cash or accrual is acceptable for Tax reporting. Modified Accrual is not and adjustments must be made at year end to convert data to one of the acceptable methods
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Accounting Methods – Which one shall I use to get the most useful information?
In all cases Accrual or Modified Accrual Accounting presents a much more accurate picture of the results of your operation as well as what you own, what you owe and the equity you have in your business.
Which Method Should the Growing PCO Use?
ACCRUALACCRUAL OR MODIFIED ACCRUAL TO RUN THE BUSINESS!!!
What about Taxes? The IRS allows us to use either method subject to certain rules which most of us will meet for reporting on a cash basis. So there are many good reasons to report on a cash basis – Taxes and simplicity for example.
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Are you telling me to keep 2 sets of books?
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YEP!
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Financial Statement Basics
Dan’s Approach to PCO Financial Statements
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Wealth Maximization!! That’s It!!
Your Financials need to be created using Generally Accepted Accounting Principles (GAAP) (with minor departures as required).
Definition:
Chart of Accounts (COA): A list of the accounts that describe items on your balance sheet and P/L.
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Think about increasing the value of your firm when devising your COA. How is it organized? It’s all about management of information that will allow you to manage your company to build maximum value.
You also need to manage your Financial Risk. Many companies have gone broke getting Rich!!
It’s irrelevant whether you want to sell or not. The value of your company is the scoreboard and you score runs by making annual increases. Will those increases be Singles? Doubles? Triples? or Home Runs?
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Financial Statement Basics
What is the most important formula in the world?
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A=L+OE
E=MC2
What is the most important Formula in the world?
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A=L+OE
E=MC2
It depends on if your objective is an explanation for the origin of energy in nuclear processes; or
You want to understand how a Balance Sheet works
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A=L+OE
E=MC2
Accounting Formula: A=L+OE
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Financial Statement Basics
Balance Sheet Basics
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Assets;What You Own
Liabilities;What You Owe
OE (Owners Equity);
Difference Between The
Two
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What does it tell us?
Assets;What You Own
Liabilities;What You Owe
OE (Owners Equity);
Difference Between The
Two
The assets (resources) that the company is using
How these assets have been funded with Owners Equity; or with
The liabilities the company owes to others
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AssetsHow much cash does the company hold?
Does the company sell on account?
How much inventory at year end?
How much machinery/buildings/etc does the company have?
Are those relatively old or new? (depending on the cumulative depreciation)
Assets;What You Own
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Liabilities;What You
Owe
OE (Owners Equity);
Difference Between The Two
Liabilities and Owners EquityThe current liabilities: how much needs to be paid within 12 months
Long term liabilities: how much needs to (re)paid in the long run
How much have the investors paid for their share
How much of profits are retained in the company (not paid as dividend)
How much potential (future) losses the company can absorb with their equity
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Example
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Financial Statement Basics
The Profit and Loss Statement
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Show Me The Money!!Revenues
Direct Costs
Gross Margin
Marketing Expense
Sales Expense
General and Admin Expense
Overhead Allocation (Firms with Multiple Branches)
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RevenuesIn the PCO world we speak in terms of valuing our firm as a multiple of revenues. While we speak this way, later I will show you how it’s really derived. However, in order to get to the answer quickly, we want to define our revenues in the following manner:
Com
mer
cial • One
Times• Initials• Route
Work• Renewals• Product
Sales
Resi
denti
al • One Times
• Initials• Route
Work• Renewals• Product
Sales
WD
I • One Times
• Initials• Route
Work• Renewals• Product
Sales
Oth
er • One Times
• Initials• Route
Work• Renewals• Product
Sales
You can add divisions as needed, but you need to separate recurring vs. non recurring work
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Direct Costs – All costs associated with putting a technician on the road
Tech Labor
Vehicle Costs
Materials
Uniforms, Tech Workers Comp, Other Direct
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Gross Margin – The single most important KPI in determining what multiple you will get when valuing your company. It determines:
How well you price your services
How well you route your technicians
How well you control your costs on the job
What your breakeven point is
What should your Gross Margin Be? Why will it determine the value of your company?
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Marketing ExpenseAll amounts spent to bring in a Sales lead. What % of revenue should I spend on Marketing?
Marketing Math:
Lifetime Value of Customer = Annual Gross Revenue X Gross
Margin X Average Life Of A Customer
Lets take a look at an example…
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Marketing Expense Example
Lifetime Value = $500 x 50% x 5 Answer: $1250 (ignoring time value of money for the real financial junkies in class with us today)
• Annual Gross Revenue = $500• Gross Margin = 50%• Average life = 5 Years
What would you pay for this customer? It’s up to you but would $125 be unreasonable? What is the % of revenue?
How many customers do you want? Is it a function of a % of revenue?
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Sales ExpenseAll amounts spent to close a lead generated by marketing. Includes:
How much do you spend on Sales?
Sales Salaries
Sales Vehicles Exp
Sales Materials
Other Sales Costs
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General & Admin ExpenseEverything else that goes on in the office
What do you spend on G&A?
Office Wages
Management Wages
Rent
Utilities
Professional Fees
Interest Expense
Other
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Overhead Allocation (Firms with Multiple Branches)
For those who have multiple branches we allocate common expenses to all by:
% of Revenue
% of Payroll
A fixed dollar amount
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P&L Example
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How does A Banker Look at Your Financials?
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“Give a man a gun and he can rob a bank. Give a man a bank and he can rob the world” - Anonymous
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How Does A Banker Look At Your Financials
Liquidity
Strength
Efficiency
Using Financial Metrics and Ratios including:
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Liquidity
Lets us know if the Company has the cash available to pay its bills
Looks at Cash, Cash Equivalents and Accounts Receivable
Looks at Cash Requirements such as unpaid bills, and other current obligations
Current Ratio =Current Assets
Current Liabilities
Quick Ratio =Cash
Accounts Payable
Liquidity Ratios:
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Liquidity Example
Liquidity Ratios:
ABC CompanyBalance Sheet
Cash 500Accounts Rec 200Inventory 100
Current =Cur. AssetsCur. Liab.
=800500
= 1.6
Quick = CashAP =
500300 = 1.66
Machinery / Equip 25000Accum Depreciation (12000)
Total Assets 13800
Accounts Payable 300Credit Cards Payable 200
Notes Payable 8500
Current Net Income 800Retained Earnings 4000
Total Liabilities & Equity 13800
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StrengthMeasured by the percentage of the company that is owned by the owners (Equity) vs. the percentage of the company owned by creditors (Liabilities). Usually measured by Debt to Equity Ratios. Companies get Capital in 1 of 2 ways:
Debt
Shareholder Investments + Any profit left in the company (retained earnings)
Debt Ratio =Liabilities
AssetsDebt to Equity =
DebtOwners Equity
Debt Ratios:
Interest Coverage Ratio =
EBITDAInterest Expense
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Strength Example
Debt Ratios:
ABC CompanyBalance Sheet
Cash 500Accounts Rec 200Inventory 100
Debt =Liabilities
Assets= 9,000
13,800 = 65.2%
Debt to Equity = DebtOE
= 90004800
= 1.875
Machinery / Equip 25000Accum Depreciation (12000)
Total Assets 13800
Accounts Payable 300Credit Cards Payable 200
Notes Payable 8500
Current Net Income 800Retained Earnings 4000
Total Liabilities & Equity 13800
Interest Coverage Ratio
EBITDAInterest Expense
Minimum of 1.25 on SBA
Debt
==
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Efficiency
Accounts Receivable
A/R Aging – What does Your Over 90 Day look Like?
Days Sales in A/R – Are Customers staying within your terms?
A/P Aging – What Does Yours Look Like?
Accounts Payable / (Annual Purchases /365)
Accounts Payable
Accounts Receivable /(Annual Sales/365)
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Efficiency
How well do you manage growth?
Degree of Operating Leverage –
Are we Holding our Margins at the Incremental Revenue Dollar?
% Change in Net Income
% Change in Revenues
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Games People Play
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Balance Sheet
Assets LiabilitiesCash
A/R
Equipment
Total
100
200
1000
700
A/P
Notes Payable
Total
200
500
300
Current Income 50
450
Equity
Capital
Total
Total Liab. & Equity
500
1000
100%
50%
50%
Let’s Play WhoOwns TheCompany?
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Assets LiabilitiesCash
A/R
Equipment
Total
0
200
900
700
A/P
Notes Payable
Total
100
400
300
Current Income 50
450
Equity
Capital
Total
Total Liab. & Equity
500
900
100%
44%
56%
Let’s Play Who Owns The Company?
Take $100 of Cash and Pay $100 A/P – Debt Ratio 44%
Debt Ratio + 400 Liab /900 Liab +Equity = 44%
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Assets LiabilitiesCash
A/R
Equipment
Total
100
200
600
300
A/P
Notes Payable
Total
0
100
100
Current Income 50
450
Equity
Capital
Total
Total Liab. & Equity
500
600
100%
16.6%
83.3%
Let’s Play Who Owns The Company?
Sell $400 of Equip and pay A/P $200 and N/P $200 – Debt Ratio 16.66%
100 Liab / 600 Liab + Equity = 16.66%
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Assets LiabilitiesCash
A/R
Equipment
Total
600
200
1500
700
A/P
Notes Payable
Total
200
500
300
Current Income 50
950
Equity
Capital
Total
Total Liab. & Equity
1000
1500
100%
33.3%
66.7%
Let’s Play Who Owns The Company?
Owner Contribute $500 to Cash as a Capital Contribution – Debt Ratio 33.33%
500 Liab / 1500 Liab + Equity = 33.33%
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What happens if the Note Payable is from a Shareholder? Is it Debt or is it Equity?
Why do people play these games with their Balance Sheet? The CFO Function is about minimizing financial risk
It’s all about Managing Financial Risk!! And a good banker can cut through all this to understand how much debt a company can handle based on their parameters
Want a lot of cash on hand in the winter – debt doesn’t matter as much
Want minimum of debt during the busy season and minimum of cash as the cash is plentiful during season and debt costs money. So debt is paid down
As a Seasonal business you will:
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How Does a Potential Purchaser or Equity Partner Look at Your Financials?
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Value and Potential Return
Value – What is the company worth?
P/E Approach:
Earnings from a P/L prepared in Accordance with GAAP
Price / Multiple – Comparable Public companies
Lets take a look at an example…
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Conversion from Price to Annual Revenue to P/E
Multiple of Revenue
Net Profit %
P/E Ratio
0.8 5% 16.000.8 10% 8.000.8 15% 5.331 5% 20.001 10% 10.001 15% 6.67
1.2 5% 24.001.2 10% 12.001.2 15% 8.001.5 5% 30.001.5 10% 15.001.5 15% 10.00
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What about Operations?Revenue Per Employee…But how do we chunk it down to departments?Total Revenue / # of Technicians – Revenue per Technician
Commercial Revenue / # of Commercial Technicians - Commercial Revenue per Commercial Technician
Residential Revenue/ # of Residential Technicians – Residential Revenue Per Technician
WDI Revenue / # WDI Technicians – WDI Revenue Per Technician
Lawn Revenue/ # Lawn Technicians – Lawn Revenue Per Technician
# of Office People / # of People on the road (Sales & Techs)
# Supervisors / # of Technicians
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By the way when a business appraiser looks at your company does he value it this way?
Most Appraisers use a balance sheet approach ignoring most of the value in the customer list.
Ever try to tell a banker what your company is worth?
When is this approach good?
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How does a Potential Purchaser or Equity Partner Look at Your Financials?
Gift and Estate Planning
Divorces – depending which side you are on
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A word about getting money out of the company – The Good the Bad and the Ugly
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A word about getting money out of the company – The Good the Bad and the Ugly
Paychecks
Distributions
Distributions in excess of Basis
Loans to Shareholders
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Case Study
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Your Next Steps
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So You want to Grow Your Firm?
For Internal Management Reports – You Need Accrual Based Reports
For Banking Relationships• You need a profitable operation• You need a healthy Balance Sheet• You need a Well organized Chart of Accounts
For Tax Reporting – You need accurate information
For Tax Minimization – You need monthly income monitoring
For Tax Audits – You need Someone who can handle the tax man when he comes knocking
You want a plan for growth – You need Financial Budgets
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www.PCOBookkeepers.com
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