1. Chart Your Course to Business Success On Target Business Intensive: Session 2 January 17, 2012 Advisors On Target 1

2. Create a working draft of your Mission Statement Create a working draft of your 1 and 5 year Vision Answer the questions on the handout Additional activities Values Exercise Business Diagnostic Assessment 2 Homework from last session

3. Effective Financial Management 3 Financial Indicators Profits, Cash Flow, ROI Cost Behavior Profit Improvement Planning More Key Performance Indicators Liquidity, Solvency, Collections, Breakeven Creating a Budget/Profit Plan

4. Best Practices: Finance Accounting system is fully & accurately functioning Controls are in place to ensure accuracy A Realistic Workable Profit Plan (aka Budget) is in place Financial Monitoring is being used effectively as a business tool Key Metrics are being used to keep your finger on the financial pulse of your business Owner reviews Financial Data and Metrics at least monthly An adequate credit line is in place Company is profitable, solvent and able to finance its growth and reward stakeholders 4

5. Sound Financial Management is critical if you wish to: Put together a solid business plan Be in the best position to obtain financing Grow a sustainable business Create a valuable company that you can later sell or otherwise provide for your exit from the business 5

6. Effective Financial Management Key Financial Data For Business Survival

7. 3 Key Financial Indicators Of Your Business’ State Of Health Business is about making money To do this, it must simultaneously increase three things: Net profit margin – Operating profit margin Cash flow Return on investment (ROI)

8. Homework Keep working on homework from Session 1 Review your own Profit and Loss and Balance Sheet and compare to what we talked about in today’s class. Start on Diagnostic assessment when you receive the link.

9. Indicator 1: Profit Margins Net Profit = What’s left over after you deduct ALL expenses from the revenue your business generates Net Profit = Total Income minus Total Expenses THE bottom line in your business Indicator of the overall management of the business Gross Profit = What’s left over after you deduct direct job costs from the revenue your business generates Gross Profit = Total Income minus Direct Expenses to Produce jobs Indicator of the productivity of your field crews Indicator of the accuracy of your estimator (and pricing)

10. How To Calculate Profit Margins Gross Profit Margin (GP%) is profit derived from work produced divided by Gross Revenue Gross Profit Margin = (Gross Profit/Revenue)% Net Profit Margin (NP%) is after-tax net profit divided by Gross Revenue Net Profit Margin = (Net Profit/Revenue)%

11. Improve The Gross Profit Margin by working on the drivers: Production / service delivery processes Material Costs Labor Costs Customer relations Team Skills and Development Pricing & Estimating Selling Skills

12. Improve the Net Profit Margin by managing: Administrative operating processes Variable Costs Overhead Costs Customer relations Administrative Team Skills and Development Marketing Activities and Costs

13. BEST PRACTICE GUIDE : Gross Profit % Gross Profit Margin = (Gross Profit/Revenue)% Higher is better 50% is goal 45% is industry average* * Residential and Commercial Contractors under $10MM, depends on mix of work, and use of subcontractors

14. BEST PRACTICE GUIDE : Net Operating Profit %** Net Operating Profit Margin = (Net Operating Profit/Revenue)% Higher is better 15% is goal (25% BEFORE Owner’s Compensation) 5% is industry average* *Residential and Commercial Contractors under $10MM ** There is a distinction between Net Profit and Net Operating Profit, which is Profit before taxes, and “other” income & expenses not related to operations of the business including financing costs (interest expense)

15. The three questions of measurement Is it Accurate? Is it Acceptable Is it Sustainable?

16. Indicator 2: Cash Flow Obtain Cash Purchase Materials Bid & Sell Contract Complete Project

17. There will be occasions when money is flowing out faster than it is flowing in Virtually every business experiences times when there is a cash flow gap Managing cash flow so as to avoid any critical situation due to lack of cash when it is needed is a major responsibility of a business owner What Does The Cash Flow Cycle Mean To Your Business Operations?

18. Businesses can make a profit but have negative cash flow Failing businesses can have positive cash flow, possibly due to large asset sales Business start-ups require large cash outlays to build the asset base = cash flow risk Cash Flow – More Than Just Profit

19. Over the longer term, you have to manage your cash flow to fund your business growth You can grow your business in the short term by ‘borrowing’ credit through late payment of suppliers Eventually, however, everything evens out and such strategies are not sustainable With that in mind, projected growth should be managed within known cash flow constraints…and if external funds are required, this needs planning in advance Cash flow Over The Longer Term

20. Improve Cash Flow Shorten the Cash Flow Cycle Understand the difference between Cash Flow and Profit Plan in advance for business growth and/or downturns

21. BEST PRACTICE GUIDE : Cash Flow Prepare a Cash Flow Projection Manage Your Spending on a monthly, if not weekly basis Invoice Promptly Develop a systematized approach to receivables and collections Obtain a line of credit

22. Indicator 3: Return On Investment Return On Investment is net profit expressed as a percentage of the value of the total assets you have tied up in the business ROI = (Net Profit/Total Assets)% ROI is a profitability ratio – it is the true measure of the financial productivity of a business

23. BEST PRACTICE GUIDE : ROI Return on Investment = (Net Profit/Total Assets)% Higher is better Should be at least 10% 25% or higher is a goal

24. ROI: An Example

25. Increase sales revenue by increasing price and/or volume Keep variable costs down (equal or below the rate of increase in revenue) Achieve greater productivity from resources which are financed through overhead Ensure that tight control is exercised over assets SO THAT Cash flow increases simultaneously with the increase in net profit The Function of Management:

26. Characteristics of Financial Health High tangible net worth (equity) Consistent profitability High cash flow from operations Cash balances representing 30-45 days of operating expenses AR representing less than 30 days sales A ratio of current assets to current liabilities (“current ratio”) in excess of 3:1 A high level of working capital A ratio of liabilities to assets of 1.0 or less (debt ratio) 26

27. How do we find out where we stand? Starts with Financial Statements: Profit & Loss Statement (Income Statement) Balance Sheet 27

28. Regarding Your Financial Statements… Accuracy is Essential GIGO Accrual vs. Cash Basis Accrual Basis – Day to Day operations Enter Invoices and Bills as they are incurred – not as they are paid Cash Basis – Paying Tax Enter data on Accrual Basis/Click of a button will show reports in either format (in QuickBooks) 28

29. Chart of Accounts Tips Good Structure Sufficient detail to analyze data Use sub accounts where more detail is needed Consider using classes if appropriate Group Expense accounts appropriately All direct costs in COGS Non Operational Income and Expenses in “Other Income & Expense” section Group Balance Sheet Liabilities appropriately Loans that will not be repaid this year in Long Term Liability section 29

30. Profit and Loss Statement Income Direct Costs (Cost of Goods Sold) Gross Profit Variable Expenses Overhead Expenses Net Operating Profit Other Income & Expenses Net Profit 30

31. Definition: Profit Margins Net Profit = What’s left over after you deduct ALL expenses from the revenue your business generates Net Profit = Total Income – Total Expenses THE bottom line in your business Indicator of the overall management of the business Gross Profit = What’s left over after you deduct direct job costs from the revenue your business generates Gross Profit = Total Income – Direct Expenses to Produce jobs Indicator of the productivity of your field crews Indicator of the accuracy of your estimator (and pricing) 31

32. Profit and Loss Statement 32

33. Balance Sheet Description Cash Checking, Savings, Petty Cash Accounts Receivable Amounts Due from Customers Other Current Assets Prepaid Expenses, Amounts due from others Total Current Assets Fixed Assets Equipment, Vehicles, Property, Depreciation Other Assets Startup expenses, Goodwill from purchase, Company deposits, Long term loans made to others Total Assets Accounts Payable Amounts owed to Vendors Credit Cards Other Current Liabilities Payroll Taxes Payable, Customer Deposits, Short Term Lines of Credit Total Current Liabilities Long Term Liabilities Loans, Lines of Credit that will not be paid off in one year Equity Contributions, withdrawals, Retained Earnings, Net Income Total Liabilities & Equity Must equal Total Assets to Balance 33

34. Balance Sheet 34

35. Key Performance Indicators Factors that indicate the current and future performance of a business in areas that are critical to the company's success.

36. Revenue to Budget Gross Profit Net Profit Break Even Sales Liquidity - Current Ratio Solvency - Debt Ratio Collections (Days Sales Outstanding) Financial KPIs

37. BEST PRACTICE GUIDE : Gross Profit % Gross Profit Margin = (Gross Profit/Revenue)% Higher is better 50% is goal 45% is industry average* * Residential and Commercial Contractors under $10MM, depends on mix of work, and use of subcontractors 37

38. BEST PRACTICE GUIDE : Net Operating Profit %** Net Operating Profit Margin = (Net Operating Profit/Revenue)% Higher is better 15% is goal (25% BEFORE Owner’s Compensation) 5% is industry average* *Residential and Commercial Contractors under $10MM ** There is a distinction between Net Profit and Net Operating Profit, which is Profit before taxes, and “other” income & expenses not related to operations of the business 38

39. BEST PRACTICE GUIDE : Liquidity Ratios Current Ratio = Current Assets Current Liabilities Should be a minimum of 1.5 or higher (3.0 or greater is better) Quick Ratio = Cash + Equivalents Current Liabilities Should be at least 1.0 Higher is better for both

40. BEST PRACTICE GUIDE : Debt Ratios Debt Ratio = Total Liabilities Total Assets Should be less than 1.0 Debt to Equity Ratio = Long Term Debt Stockholder’s Equity Should be less than 1.5 or 150%

41. BEST PRACTICE GUIDE : Days Sales Outstanding (Collections) Days Sales Outstanding = Accounts Receivable x 365 Annual Revenue (previous 12 months rolling revenue) Should be 30 days or less

42. BEST PRACTICE GUIDE : Cash in Bank – Ideal Cash in Bank = Overhead Expenses* (next month) Gross Profit Margin Plus: Fixed expenses for months 2 & 3 Or – just think 3 months fixed expenses for a quicker calculation *Include Variable Costs and Overhead Costs

43. BEST PRACTICE GUIDE : Cash in Bank – Ideal Cash in Bank = Overhead Expenses* (next month)/Gross Profit % Plus: Fixed expenses for months 2 & 3 Or – just think 3 months fixed expenses for a quicker calculation *Include Variable Costs and Overhead Costs 43

44. BEST PRACTICE GUIDE : ROI Return on Investment = (Net Profit/Total Assets)% Higher is better Should be at least 10% 25% or higher is a goal 44