Monday, January 28, 2013

Discussion points for creating an operating agreement

Having an operating agreement for a multi-member LLC or partnership is not only a legal requirement, it is also a key to a successful operation.  Here are some questions each individual should answer and then compare to see if you are ready to start your business.

1. How much money will each contribute? (Suggestion: Both should contribute equally. Avoid sweat equity situations as one partner will become resentful of the other).

2. Is equity ownership equal? (Suggestion: Decide if it is best to have equal ownership to avoid disputes and resentment or if it is better to have one partner with slightly higher % to avoid “ties”)

3. What is initial capital contribution? (Suggestion: Make it equal, put it in a bank account, and draw ALL expenses out of that account).

4. What if one partner isn’t holding his/her weight? (Suggestion: Give 30 days to correct, and then set up buyout arrangement). Also determine what will happen if a partner is incapacitated due to mental or physical illness.  How long can they be ill without working and what will happen?  How will you determine if they are incapacitated?

5. What happens if partner dies and has spouse/family? (Suggestion: Let shares pass to spouse, or buy spouse out at market. But spouse has no voting rights, and can only sell his/her share with written approval of other partner). Also put in wording regarding a divorce.  Wisconsin is a marital property state and you probably don’t want an ex-spouse as a new partner.

6. What if one partner wants out? (Suggestion: Do you want to penalize a partner for wanting out. Don’t reward him or her. Appraise the enterprise and then buyout over a period of time at a discount)

7. Once profits appear, do you reinvest or pull money out? (Suggestion: Decide this before you sign the operating agreement)

8.  How will you pay yourselves?  Will you take even draws based on the excess amount in the checking account or will it be based on hours worked or billable hours worked or revenue created by each partner?  Be very specific.

9. What is your exit strategy? (Suggestion: All must agree on ultimate goals of venture and time frame to get out).

10. What is your growth/operating strategy? For instance, is it slow and steady growth, or massive investment to get customers? Are you frugal or do you get a nice office to impress investors, or something in between?

11. What is capital strategy? When will you take on debt? (For growth, for capital equipment, to fund losses?)

12. How will you resolve disagreements?

(Suggestion: Select someone now to act as arbitrator)

(Suggestion: Handle all disagreements in person, not on the phone or via email)

13. What specific tasks will each partner be responsible for? (Personnel, finances, dealing with the landlord, dealing with the bank, marketing, etc.)

14.  Review the mission statement of the business to make sure you are in agreement as to the main focus of the enterprise.

Everyone must be in agreement on all these points before the business can begin.  Getting this in writing is the best way to insure a successful business partnership.

Wednesday, January 23, 2013

Do you have an exit strategy?

Small business owners wear many hats and it is often hard for them to find the time to do strategic planning.  We try to encourage our clients to sit down once a year to see where they have been and where they are going.  This doesn't have to be done at the end of the calendar year if this is a hectic time of year for you.  We usually do this in the early fall as we are very busy in December and January!

Planning your exit strategy should be an ongoing process. If the business has more than one owner, it is vitally important to keep everyone on the same page as to where the business is going and how it will end.  If the plan is to sell the business some day, keep in mind that a potential buyer will want to look at your financial statements and accounting records.  Getting and keeping these in order is important and the sooner you do it, the better.  When you are taking draws or paying bonuses, keep the big picture in mind.  While keeping profits to a minimum helps reduce taxes, it may limit the attractiveness of your business to potential buyers.  You also want your accounting to have enough sophistication to impress a larger company.  Simple works initially, but corporations expect to see prepaids and accruals on the books so if selling the business is your long range plan, consider adding these accounting conventions to your process.

It is also good to start establishing a persona for your business that is not tied so closely to you.  If you are the business, who will want to buy it?  You need to have procedures and processes in place which can be duplicated by a new owner.  They want to see that your customers or clients will stay with the business in the event of an ownership change. 

Take some time at some point in 2013 to work on your exit strategy.

Monday, January 14, 2013

Statement of Cash Flows, Part 2

So what does the Statement of Cash Flows look like?  It starts out with the net income for a business.  Obviously, if the business is making a profit, it helps the cash flow!  Next, the statement accounts for changes in the balance sheet accounts. This is called the Cash from Operating Activities section and  is where many people gets confused as they tend to think of increases in assets as a good thing.  Generally this is true, but it does have an impact on cash flow.

If your accounts receivable have increased from the beginning of the period to the next, this means you have earned income, but you haven't collected it yet.  You incurred the expenses to generate the income, but you haven't collected the actual cash yet.  Increased in inventory are a little easier to imagine as it cost the business money to purchase the inventory and while it is sitting on your shelves, it is not bringing cash into the business.  Shortening the terms your offer your customers brings in cash faster as does turning over your inventory more quickly.

On the liability side, the opposite holds true: increases in liabilities generally means improved cash flow.  This is because the business has received goods or services it needs to run but hasn't had to paid cash for them yet.  Receiving longer payment terms from your suppliers or vendors is one way a business can look to improve it's cash flow.

The net change in assets and liabilities related to operations either increases or decreases cash flow during the period. 

Next the business looks at investing activities.  The accounting world considers purchases of fixed assets as investments in the business, thus your will see increases in fixed assets in this part of the Statement of Cash Flows.  While every business needs certain fixed assets to operate, buying them does eat up cash flow and an owner always considers this when deciding whether to purchase new equipment or vehicles or furnishings. 

Principal payments for loans or new loans will also show up in the financing area.  A new loan will bring cash into a business while payments eat up cash.  Owner contributions and draws are also accounted for in the financing activities area of the statement.  The amount an owner draws from a business has a big impact on the cash flow.  Balancing personal needs with business needs is something every small business owner needs to consider.

At the end of the statement, the net change in cash is calculated.  This can show how a profitable business is running short of cash or how a business suffering a loss can still be in business.  Studying the different pieces of the Statement of Cash Flows is a good way to figure out how to improve your small business.

Monday, January 7, 2013

Introducing the Statement of Cash Flows

I was helping a new client close the books for 2012 today.  We reviewed her P&L and she wanted to know why her draws didn't show up there.  I took her to the Balance Sheet and showed her where the draws were located.  She wanted to know if there was a way to look at both the income and expenses on the P&L and the draws as well since they have a big impact on the money in the business' checking account.  I introduced her to the Statement of Cash Flows.

The Statement of Cash Flows tells you how money came into your business and how it went out regardless of whether it was a balance sheet item (inventory, accounts receivable, fixed assets, credit cards, bank loans, draws) or a P&L item (sales, advertising, interest, rent, telephone expense).

It is quite possible for a business to be profitable and yet to find itself without any money in the bank and the Statement of Cash Flows can show the owner why.  There may be too much debt and the loan payments may be eating up all the profits.  The business may give its customers more time to pay that its suppliers give the business so the money is going out faster than it is coming in.  Studying the statement give give an owner the answers she needs to fix the cash flow woes.  She may need to renegotiate terms with her suppliers or shorten the terms she gives her customers.  She may need to refinance her debt to have a longer term and lower payments. 

My client was excited to have someone explain how cash flow works.  She looks at her financial statements frequently but she had never been shown the Statement of Cash Flows.  Now she has a better idea of what to look at when she is determining the size of her next draw.

Stayed tuned next week for greater detail on the Statement of Cash Flows!