CFO Services - Inventory Planning For Profit

As a Part Time CFO where I have multiple clients, there are many clients when I engage with them for the first time that I find do not have an inventory plan/forecast. An inventory plan/forecast is an essential tool and is one of the essential CFO Services in order to manage cash flow and reduce risk to the business owner. Retailers especially need this tool because inventory to a retailer represents one of the retailers’ greatest risks, but the need for this tool also holds true in distribution and manufacturing companies.

An inventory plan or forecast is different from an open to buy plan. Most retailers have an open to buy plan by product classification. The open to buy is calculated by taking projected sales in the product classification (retailers usually use last year’s sales. They should work with a CFO to prepare a more legitimate sales forecast taking other economic, market variables and the retailer’s knowledge of the customer into consideration) and adding the desired ending inventory you want to have at the end of the period you are buying for and then subtracting the beginning inventory for the product classification. The result is how much you should buy or is known as your “open to buy”. You can use cost dollars, retail dollars or units in the aforementioned calculation. You can also include planned markdowns, average markups and other factors. I like to keep it simple and use units.

Example of “open to buy” calculation:

Product class	Calculation Item	Units
Phillips Head Screwdrivers	Projected Sales	500
	Add : Desired Ending Inventory	50
	Less: Beginning Inventory	100
	Open to Buy	450

Now there are other factors that retailers consider (justified or not justified) that increases their “open to buy”, for example:

1. How hot the buyer thinks the product will be (This will increase projected sales and therefore increase open to buy)
2. Sizes you may have to fill from beginning inventory to complete size runs or decisions to carry larger or smaller sizes to fit a certain customer segment
3. Colors you want to add because you think they will have greater consumer appeal
4. Merchandising plans that have higher stocking requirements to fill rack or shelf space properly
5. There may be a bad product mix or obsolescence in beginning inventory for the product classification and therefore the beginning inventory needs to be reduced to account for that
6. Better payment terms offered by supplier
7. Extra discounts from suppliers at certain quantities
8. Pressure from a supplier to buy more or they will threaten to open a competitor.
9. Pressure from a supplier to buy more who is giving you more advertising money
10. Pressure from a supplier to buy more because they have given you great support or provided you with favors in the past.
    

Do you see how you can overbuy? Do you see how easy it is to commit the greatest sin in retail? Some of these aforementioned examples are justified, others are not. All of these factors create more risk.

Items 1 through 5 above and are legitimate reasons for taking additional risk and increasing your open to buy if you really did your market/customer study homework. Item 6 above is legitimate only when you are considering the timing of shipments. Items 7 through 10 above are booby traps and are not legitimate reasons to go over your open to buy and take additional risk. In a future article I will explain why the booby traps are booby traps, but the purpose of this article is the absolute need for an inventory plan/forecast.

Let’s say that you have ice water running through your veins and you do not succumb to any pressure. You simply use your experience and knowledge and if you do go over your open to buy in a product classification you legitimately feel a product is going to be hot or you have to complete size runs or there are colors you believe will be in great demand or you have a new merchandising plan that has higher stocking requirements or your beginning inventory could be completely stale and you have to discount a lot of it. Even though you have these legitimate reasons for overbuying you are still assuming greater risk and you need to understand the extent of the risk you are taking and that is where the inventory plan/forecast comes in.

Most retailers just have their open to buy analysis by product classification and call it a day. However they are missing an overall top level inventory receipt plan and inventory forecast. Why does the retailer need an overall top level inventory plan and complete inventory forecast in addition to their open to buy by product classification? Because this plan/forecast gives the retailer a macro view to clearly see how overbought or under bought they are as well as to see what the impact on cash flow will be. This helps the retailer measure their risk and see what is really going to happen at the entire company level.

This plan/forecast starts with beginning inventory and then adds the inventory receipts on order and lists them by the month they will be shipped in and subtracts the costs of the projected sales by month to determine ending inventory by month. You will be able to see how the projected ending inventories by month compare to last year’s monthly ending inventories. However that is not enough. You may have overbought last year. The final test should be entering your inventory plan into a business and cash flow forecast and letting the projected cash flow tell you if you are overbought. In the business and cash flow forecast you must also plug in the proper months when the supplier invoices will be paid. If you find that the business and cash flow forecast tells you that you are going to be out of cash during the year then you are likely overbought and are assuming great risk. Here is an example of a sample inventory plan/forecast for a 3 month period:

Inventory Plan - Numbers in ($000)	Jan	Feb	Mar
Beginning inventory	$ 85.0	$ 90.0	$110.0
Add: Projected Receipts Product on order	40.0	60.0	70.0
Less: Cost of Goods sold on Projected sales	35.0	40.0	50.0
Ending inventory	$ 90.0	$110.0	$130.0

A/P Trade Plan - Numbers in ($000)	Jan	Feb	Mar
Beginning Trade Suppliers Accounts Payable	$50.0	$ 40.0	$ 60.0
Add: Projected Receipts Product on order	40.0	60.0	70.0
Less: Payments to Trade Suppliers (30 Days)	50.0	40.0	60.0
Ending Trade Suppliers Accounts Payable	$40.0	$ 60.0	$ 70.0

In this example the retailer may want to rethink purchases as inventory is rising. Certainly this could be gearing up for a busy period but even if that is true you must still assess if you are bringing inventory in too early especially if your trade terms are 30 days or less.

As mentioned, an inventory plan/forecast works best when it can be plugged into a business and cash flow forecast, but it is still useful to give the retailer the macro view of the impact of inventory ordered. The Trade Accounts Payable Plan should also be prepared as part of this inventory planning/forecasting process.

One of the CFO’s major responsibilities is to reduce risk. To the retailer inventory represents the greatest risk. I have seen many retailers overbuy their way out of business. The Chief Financial Officer (CFO) needs to guide the retailer through the inventory planning/forecasting process.

CFO Services - A Difficult Employee Question

As a Part time CFO I am often in a position to advise clients how to answer the following non financial related question:

What do you do with an inferior employee(s) when the business owner is virtually convinced that the employee market for the particular skill that the inferior employee(s) is in is so thinly populated and thinly skilled the replacement would either be worse or no replacement exists? Assume the inferior employees are not stealing. They just lack the talent, the ambition or they are just plain lazy and incompetent.

Many may say that it is impossible for a skill set in an employee market to be that thin. Many may say this is an easy decision and that you just get rid of the inferior employee(s).

These are all legitimate comments but what happens if the market is really that thin? What happens when the loss of the inferior employee results in a loss of business for an unknown period of time? What happens if the training costs to train the new employee who is being plucked from a thinly populated and talented market is expensive?

I have personally faced these types of situations in businesses that I have owned and they do happen contrary to many who believe that an employee market no matter what the skill set can be thinly populated and thinly talented. In the two specific situations I was personally involved in as the business owner I kept the inferior employees and as a result I believe I paid a higher price versus biting the bullet, letting go the inferior employees and paying whatever price I had to pay including lost business.

What I found was that inferior employees bring down other employees who are more talented, more ambitious and more willing to work. The inferior employees are the proverbial "Bad Apples" that spoil the whole bunch and as a result everyone goes down with them making the whole operation that much more inefficient, ineffective and dis-serving to the most important people in the process, the customer.

Believe me; I understand how tough the decision is to cut the cord. You know that you are going to spend a lot more sleepless nights while you lose business and do not have replacements. You will personally have to work more hours and this can be taxing especially when you already work crazy hours. It tears the very fiber of the business owner, but it is one of those unfortunate situations business owners encounter.

The key is take every precaution you can to prevent this during the hiring process and during the employee's first 90 days on the job.

Even though this is a non-financial challenge a CFO has more value to their clients if they can guide the client through this challenge and provide real life insight. It is the CFO who has prior business ownership experience that is best equipped to handle these situations. At the end of the day these non-financial insights can be one of many valuable CFO Services.

CFO Services - The Power of Control

I am a Part Time Chief Financial Officer. I was asked recently by a colleague,”when does a client become a client? Is it some particular CFO Service that they are looking for? Is it usually some problem the client is having whether it is solving cash flow problems, getting the business owner to know their numbers, Preparing a business and cash flow forecast or doing some strategic planning?” I responded by saying that certainly the potential client could be looking for specific CFO Services or for solving a specific problem, but the client really doesn’t become a client until they feel some loss of control of a particular problem in their business. For example a potential client may feel they have a cash flow problem, but if rightly or wrongly they can justify in their mind that they can solve the cash flow problem, they feel they have control of the situation and so they say “I can solve this one, why pay someone to solve it?” Of course, the potential client does not understand that a good CFO can identify potential problems, like cash flow problems before they occur. The potential client does not understand that through the use of the right business and cash flow forecasting tools a good CFO can tell the business owner that trouble is brewing and what to do to prevent the trouble. So it is all about the level and sense of control.

As someone who has owned retail, manufacturing and service companies for 25 years I surely can say one of the most uncomfortable feelings for any business owner is the feeling of a loss of control. It only has to be the feeling of a loss of control in one aspect of the business. It doesn’t have to be the feeling of a loss of control of the entire business. The fear and the risk of loss that you feel when you feel a loss of control can be numbing. Conversely, there is no greater feeling for a business owner than the feeling of having control over their business and being able to solve most all problems or issues that come their way.

The potential client underestimates the value of strategic planning. Through the strategic planning process that wonderful sense of control begins to emerge and when the planning process is through and it is then maintained on an ongoing basis that sense of control becomes a more permanent posture of the business owner and confidence ensues. One thing the potential client never underestimates is the power of control.

CFO Services - Reducing Business Risk

What would you dare to dream if you knew you wouldn’t fail?

By asking this question I am attempting to put you in the mindset of my clients. I am attempting to put you in the mindset of a business owner, of an entrepreneur. Many of you are probably already in this mindset, but for those who are not, I believe by understanding this mindset it will help you understand this post, because my clients are of this mindset. My clients are entrepreneurs. They will do what others might only dare to dream. They are risk takers because running a business and doing what others might only dare to dream involves great risk. As a part time Chief Financial Officer it is my job to reduce that risk. This is my primary purpose and the primary purpose of a CFO. All of the things that I do is done to achieve the ultimate goal of reducing the risk of business ownership for my clients. Reducing risk gives the business owner more time and more freedom to find and create opportunity.

I see a lot of business owners and the one thing the most successful business owners have in common is the most successful business owners “Know Their Numbers”. They understand their costs, they understand their cash flow, and they have a basic understanding of their balance sheet. By knowing your numbers you are able to make better business decisions and when you make better business decisions you reduce risk.

Knowing your numbers starts with having accurate financial statements and if you don’t have a bookkeeper to accurately maintaining your books and records I guarantee at some point you will be in a lot of trouble. Strong sales can cover a lot of mistakes, but when the sales slow down the strategies you employ during that difficult time depend on financial analysis and if you have bad numbers, forget it.

Simply put, whether times are good or bad, with accurate financial statements you make good business decisions, with inaccurate financial statements you make bad business decisions. Some people say, Why do I need accurate financial statements, I don’t make any decisions based on my financial statements anyway, and I say, that’s called managing by the seat of your pants and guess what, your competition is managing by knowing their numbers. And that’s why people who manage by the seat of their pants and don’t know their numbers, get crushed when sales slow down or in an economic downturn.

By knowing your numbers you will be in control of your decisions, you will be in control of your business and most importantly you will reduce your risk. I wrote a lot about risk today and that ultimately the main reason people hire me is to reduce risk. The Free spirit of the entrepreneur is inherently prone to risk because remember, it all started with the question “What would you dare to dream!!”

CFO Services – Know Your Numbers

As a Part time CFO I see a lot of Business Owners and the one thing that the most successful business owners have in common, is that the most successful business owners Know Their Numbers.

What does it mean to Know Your Numbers? Here are just a few things that it means:

It means understanding and knowing what your operating costs per hour are.

It means understanding and knowing what your gross margin percentage is on key products.

It means knowing which products you make the most money on and what products you make the least money on.

It means knowing your inventory and what is slow moving.

It means knowing your inventory turns ratio.

It means knowing your average wage rate of direct laborers

It means staying on top of how many days your receivables are outstanding

It means knowing how many days your payables are outstanding and knowing when to time all of your disbursements.

It means being able to answer a question with total confidence when an employee or a vendor needs a decision because your answer is centered on the knowledge you have about the most important numbers/metrics in your business.

It means increasing the overall accuracy of your decisions

It means improving the productivity and performance of your business because you are able to evaluate the productivity and performance of your business.

It means understanding the metrics associated with your advertising campaigns

It means knowing how much cash you have on hand at all times.

It means you know what your monthly debt service is.

It means knowing how productive your capital expenditures are.

When a business owner knows their numbers they are on top of almost all business scenarios that can take place in their business. They have a stronger sense of control over their business. Most importantly, the business owner who Knows Their Numbers reduces the risk of business ownership!

CFO Services – Guidance to the Entrepreneur with an Idea

As a Part Time CFO who performs multiple CFO Services I very often come across entrepreneurs with an idea. It is great to see the enthusiasm and the passion the entrepreneur possesses about their new idea for a product or service. I do not call these situations start-up companies yet because they are just an idea and not something that was put into motion. To me a start-up company is an idea that had been put into motion.

One problem I notice very often is that the entrepreneur thinks that the idea is sellable to an investor as an idea. For example, an entrepreneur has an idea for a new widget that will solve a particular problem in the medical industry. However, it is just an idea. There is nothing tangible. Oh sure, there may be a bunch of doctors that were polled who will say that it will work, but there is no prototype of the widget therefore an investor will question whether the widget can actually be produced. The investor will also question the costs the widget can be produced at because since it has not been produced no one has any idea of what manufacturing challenges exist that may escalate costs. The idea doesn’t even have a contract manufacturer lined up to at least identify someone who can possibly produce this widget. I could go on but the bottom line is that the entrepreneur must take their idea and create as much tangible evidence as possible to support the success of the idea.

The objective of an entrepreneur with an idea is to create as much tangible evidence as is humanly possible in order to convince an investor to make a maximum amount of an investment in exchange for the least amount of equity. The more holes in your idea the lower an investment you will attract if any and ultimately you will give up the most amount of equity. Investors do not invest in ideas. They invest in solid business plans and business models with strong management chock full of tangible evidence that they will get a return equal to 5 to 10 times their investment in five years.

The Part Time CFO can help the entrepreneur develop the business plan, prepare the forecasts and the financial section of the plan, be a strong part of the management team, help develop the strategic plan, find investors, help pitch the deal to investors. These are essential CFO Services.

CFO Services - Financial Numbers Can Play Tricks

If a baseball bat and ball together cost $1.10 and I told you the bat costs one dollar more than the ball. How much does the ball cost?

Most people say the ball costs 10 cents. The right answer is the ball costs 5 cents with bat costing one dollar more than the ball or $1.05 for a total cost of $1.10.

The reason why I bring this example up is because financial numbers can play tricks on you. It is the job of a Part Time CFO to understand all of the tricks numbers can play and help the business owner understand and interpret the financial statements properly so better business decisions can be made.

Reading and understanding the financial numbers on financial statements can play tricks on you. Many times a company is making money so the P & L looks good, but they have poor cash flow. This is the case usually because the cash cycle is too long (The cash cycle is the time frame between the outlay of cash for inventory (and material and labor) and the ultimate receipt of cash from customers). These time frames need to be compressed. Some of these issues to compress the cash cycle involve negotiations with the trade for better terms as well as stricter company credit policies for faster accounts receivable turnover. Sometimes a solution can also be extending payroll from weekly to bi-weekly or even monthly where it is legal to do so. Some clients also need an inventory purchase and receipt plan as they may be overbuying inventory.

To understand better how profit does not equal cash watch the following six minute and 30 second presentation:


Profit Does not Equal Cash Presentation

Another trick that financial statements and financial numbers can play is in understanding the equity section of the balance sheet. This is the section of the balance sheet that values the difference between assets and liabilities. A high equity balance can be deceiving if a high percentage of assets are made up of intangibles like goodwill, non-competes or patents and trademarks. A high equity balance can also be deceiving if a high percentage of assets are made up of machinery, equipment or other fixed assets that depreciate in actual value faster than the accounting depreciation calculation.

Accurate gross profit margins on your P & L can play tricks on you. Understanding what needs to go in cost of goods sold and what is a direct cost of the product or service is very often done incorrectly. For example many business owners in the trades such as construction, electricians, plumbers etc… and who are in manufacturing do not put direct labor in cost of goods sold. This is leaving out a direct cost of the product or service and without it will inaccurately overstate gross profit margins which can lead to poor business decisions.

Helping the business owner read and understand their financial statements in order to make better business decisions is a CFO Service that needs to be done early in the process. Remember, financial numbers can play tricks on you.