As Year-end Approaches, Finish Strong and Focus Forward

As CEOs and other leaders come to grips with the reality of another year quickly coming to a close, many simultaneously recognize that it is a vital time to take stock of what needs to be done to strengthen one’s business and get it to where we want it to be. And while “taking stock” can take many forms, the overriding premise is to look deep, finish the year strong, and focus forward on the opportunities for the year ahead.

Finishing Strong

Evaluate Year-to-Date Financial Performance and Push Hard to the Finish

How have we done year-to-date?  It seems obvious, but actively reviewing actual vs planned results and understanding the variables that were at play is imperative.  Are targets being consistently met?  If we are behind in aggregate, what is the gap and what actions can we take to close it?  This review often starts with assessing topline revenue and then examining gross margins, overhead expenses, net income, EBITDA and free cash flow. And It likely goes without saying, but the longer one waits to begin this examination, the less time they have to implement changes to move things in the desired direction.

When it comes to revenue, this review will often involve examining sales performance. By nature, most salespeople will do exactly what they are incentivized to do (which is why a well-designed sales compensation plan is so important).  If a revenue shortfall is recognized, should incentives be adjusted for the sales team to close deals and book revenue before year end?  Or is it the customers that need to be incentivized with year-end offers? Or, if expenses are found to be running over budget, are there line items that can be cut or deferred to pull my overall expenses back in line?

Tax Planning is Essential

A wise person once said that failing to plan is planning to fail. This can certainly be true in the area of taxation where there are often opportunities to legally minimize or defer the timing of tax payments and to claim income tax credits.

There are generous allowances in the tax code to write off purchases of capital assets. If equipment is needed, it may not make sense to wait until January to buy it. In most cases, one can get a 100% tax write off on such purchases. And with recent changes to the tax code, used equipment also qualifies for these incentives. For entities filing on a cash basis, taxes can be deferred by paying bills early, paying variable compensation such as commissions and bonuses in December.

Many entities undertake activities that would qualify for the generous R&D tax credit and don’t even know it.  This can include software companies, manufacturers and many who may not even have thought of themselves as a research-oriented business.  The range of qualifying activities is broader than most would assume.  The credit is available to offset against income tax that would otherwise be payable.  For entities that do not have an income tax liability, the credit may also be monetized quarterly by an offset against a portion the employer payroll taxes.

More sophisticated tax strategies can be developed in conjunction with an entity’s CPA.  For example, companies that are generating cash can set up a profit share plan with an attached 401k (including existing plans).  Contributions are fully deductible even if made after year end.  It is a tax effective way of bonusing employees and provides significantly greater deferral limits for highly compensated employees.  Furthermore, the plan can be tailored to include a vesting option which serves to help retention of key employees in a tight labor market.

Evaluating the Balance Sheet

Year-end also marks a good time to review each line of the balance sheet and consider what actions might be required in order to present a more pristine picture at year end.  These actions might include:

• A blitz on collection of past due receivables to reduce cash tied up in past due accounts, reduce bad debt exposure and improve DSO (days sales outstanding – a metric often scrutinized by lenders).
• Identifying slow moving inventory and developing a strategy to get it off the shelf. Year-end sales or special offers to past customers for that product might do the trick.
• Reviewing the asset register and eliminating assets that have been scrapped.
• Evaluating the carrying value of intangible assets such as goodwill and intellectual property.

Assessing Accounting

For non-public entities preparing GAAP compliant financial statements, adoption of the new Revenue Recognition Standard (Topic ASC 606) is now mandatory.  If you’re a vcfo client, we have talked with you about this and likely made already the necessary changes.  If you are not a vcfo client, and you are unaware of the implications of the new standard, know that there’s a good chance that you will be impacted and ensure you are prepared.

Changing how revenue is reported impacts EBITDA and also balance sheet items such as deferred revenue and deferred expenses.  These changes could impact loan covenants, targets on which sales and management compensation is based, calculations of earnouts, etc. And looking ahead, a new accounting standard is expected in 2020 that will affect the treatment of leases. Finance should be thinking through the impact of standards like these as they may warrant pre-work or changes to practices.

Now is also a good time to reach out to auditors (if an audit or CPA review is required) to plan the timing of the audit, discuss material changes in the business that might impact financial results and/or disclosures,  and to obtain a list of their “PBCs” (schedules to be “prepared by client”).

What About Borrowing?

Most lenders do not lend money unconditionally.  There are usually strings attached to any loan and it pays to ensure full compliance with debt covenants and one’s ability to meet deadlines for the furnishing of year-end financial reports (e.g. audited or reviewed financial statements).  If a problem is detected, a proactive approach to submitting a request for a covenant waiver is more likely to succeed than a belated admission after the fact.

Focusing Forward

With a fully completed year end project plan which includes, among other things, the actions required to close the books, completion of the audit and tax returns, issuance of W-2s and 1099s and filing of payroll and HR related reports with the relevant authorities, it is then time to think about goals for the year ahead. This can be approached in steps:

1. What is the Single Long-term Make or Break Execution Goal for the Business?

This is the one long term factor that is going to ensure that the business out-performs over the long term.  For a seafood company, it may be delivering a product that is fresher than our competitors.  For a pizza company it may be delivering a product faster than our competitors.

2. What Must we Achieve in 2020 to Support our Make or Break Goal?

A CFOs priority – always – is to ensure that the business never runs out of cash.  Prepare the coming year’s operating plan helps to ensure this and will include a revenue forecast, a hiring (or in some cases a reduction in force) plan, departmental operating plans, a capital expenditure plan and often more. These then roll up into a consolidated projection of operating results, cash flow forecast and balance sheet.

As Yogi Berra once said, ‘It’s tough to make predictions, especially about the future.’  Therefore, it is important that the planning not be done by the CEO and CFO in isolation, but that management is fully engaged.  Their perspective will result in a stronger and more accurate product.  This operating plan can and should also be used in setting targets for management and the sales team and to finalize and communicate their respective compensation plans.  Individuals are more likely to accept a portion of their income being at risk based on the attainment of stretch goals if they had a role in formulating those goals and understand the importance of meeting them.

From these projections, one can determine with a margin of safety built in, what additional funding (if any) may be required.  It can also be used to calculate and benchmark certain KPIs that are applicable to the industry to ensure that they are in line and support our funding objectives.   If debt is required the plan will calculate projected covenant ratios.   If equity funding is required, one should also incorporate the existing cap table and project the impact of the finding round so that can be communicated to the Board and others as needed.

The looming year end is an opportunity for owners and CEOs to engage with a strategic CFO and seasoned HR professionals to develop a thorough project plan and execute a disciplined management process thereby affording them more time to think, communicate and collaborate to make their business stronger.

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Have questions on how to close your year right and make your company stronger in the year ahead? Request a free consultation from a vcfo expert who can help.