Make your company more attractive to buyers with a tax election

Sellers of middle-market companies are increasingly engaging advisers to perform sell-side due diligence before they go to the market. Part of the due diligence process involves evaluating tax structuring opportunities, including tax elections that deliver a step up in the basis of the assets for the buyer.

“Sophisticated buyers have understood this for a long time. Now, sellers are starting to appreciate a buyer’s desire for this, so they want to get out in front of it,” says Dave Godenswager, senior manager, Transaction Advisory Services at BDO USA, LLP.

Smart Business spoke with Godenswager about how deal structure impacts a company’s tax expectations during a sale.

What do you mean by tax elections that step up tax basis?

There are two ways to buy a business. A stock acquisition — easier to document from a legal standpoint and an advantage for certain customer contracts — is where a new owner purchases the stock or units of the business. In an asset acquisition, the assets of the business are sold to the buyer while the selling entity remains intact. In some cases, a stock transaction can be treated as a sale of the assets for tax purposes.

If a buyer purchases assets, or has the ability to treat the transaction as if he or she purchased assets, the buyer may be able to amortize the purchase price for up to 15 years, which in turn lowers the buyer’s future tax costs. This tax shield is compelling for private equity firms in particular because they typically want to hold a company for five to 10 years and are focused on the company’s cash position.

Buyers have historically keyed in on this, and middle-market sellers can use these techniques to make their company more attractive and marketable. They also can look at this when going to market, asking, ‘Is there a possibility we can monetize this or use it as a negotiating point?’

How does a seller know whether or not this is possible for his or her company?

Generally, as a seller, before going to market you want to consider your company’s tax profile to understand potential tax exposures and opportunities. You want to be in a position to say, ‘Yes, we’ve identified this and we’re taking certain steps.’ During due diligence, advisers can help determine if there is an opportunity to implement certain pre-closing reorganizational steps. For instance, consideration may be given to a Section 338(h)(10) or 336(e) election or perhaps an F reorganization, such that the seller is able to deliver a step up in the tax basis of the assets to the buyer.

Since many middle-market organizations are taxed as flow-through entities — S Corporations, limited liability companies or partnerships — they are uniquely positioned to deliver some of these tax benefits.

How important is this in today’s market?

It’s been a seller’s market — with few high-quality companies on the market, private equity firms are chasing the same deals. While the deal space is still hot for sellers, there is uncertainty about tax reform and what a potential border adjustment tax could mean for businesses. Understanding structuring opportunities gives the seller a better chance to get a transaction closed.

What else do sellers need to know?

Sellers want to understand and express the deal structure to the buyer before signing the letter of intent. Some structures may result in incremental taxes, and therefore sellers need to be clear with buyers that they intend to be compensated for these tax costs. Often, buyers are willing to do this because the tax benefits are compelling.

It’s also important to have an adviser who understands the structuring nuances in order to calculate an accurate gross-up payment. Historically, sophisticated buyers have had that, but sellers are realizing they need to make sure they are getting adequately compensated since incremental taxes could include recognizing ordinary income, built-in gains tax for S Corporations and certain entity-level taxes. Sellers also need to be focused on potential accounting method changes and the impact of deferred revenue as a result of the transaction.

The tax opportunities may not change the legal form of the deal, but there are certain provisions that will need to be tailored in the purchase agreement. It is a nice benefit that sellers can present to buyers to become more attractive in the market.

Insights Accounting & Consulting is brought to you by BDO USA, LLP

Employees play a critical role in protecting your company’s data

Cybersecurity is an ever-present concern for business leaders with valuable data to protect and multiple potential entry points to secure against being infiltrated by hackers, says Sassan Hejazi, Ph.D., Director of the Technology Solutions Group at Kreischer Miller.

“The companies that are most prepared have upgraded their protections on hardware devices and infrastructure, as well as implemented protocols to safeguard their materials,” Hejazi says. “However, even these proactive organizations face vulnerabilities.”

Cybercriminals tend to be quite resourceful and are constantly in search of new ways to wreak havoc on systems and networks everywhere. Your employees need to be aware of this constant threat and should be armed with knowledge and tools to help protect your company against an attack.

“A continuous awareness mechanism that begins at the top and cascades all the way down to new hires is the best solution,” Hejazi says. “Enable employees to not only identify security threats, but also to act as a deterrent towards such threats.”

Smart Business spoke with Hejazi about the tools available to reduce your risk of a cyberattack and the value of continuous employee training.

What steps are most effective in any cybersecurity initiative?
The measures you implement to secure your company need to be built around user awareness and training.

Technology changes on an ongoing basis as upgrades are made to both hardware and software and new tools and applications are developed. Educate employees so they know how to respond if they get a questionable email request. Ensure that they understand the risk of transferring data from your company network to a home network, where the employee or family members could inadvertently expose sensitive files to the outside world by visiting unsafe websites.

Keep in mind that even if these files are stored on the same computer the employee uses in the office, that computer is now being accessed through a potentially unsecure network. Also, laptops can be stolen. Take steps to encrypt important information so that even if it does fall into criminal hands, it will be difficult to decode.

It’s wise to implement practices that cover things likes printed files. These documents should not be left on the printer for any length of time, nor should they be left at someone’s desk where the information could also be exposed. Most security breaches occur due to human error. Even if it’s an unintentional lapse, it can still create a significant problem.

How can social engineering play a part in protecting your company?
Many middle-market companies have outsourced their IT duties, often through a help desk function that can be accessed by employees.

It’s important that someone be designated as the contact point to address these concerns, even if it’s not a full-time person who is on site every day. You don’t want a cyberattack to occur that could have been prevented had there simply been an IT person in place to field a question.

Online courses are another effective tool to teach employees about smart technology practices. You can subscribe to courses and develop an ongoing curriculum for your employee that addresses updates and changes as they occur.

Another successful strategy is penetration testing. Create a scenario such as a fake phishing email, send it out to a select group of employees and see who responds. It’s always better if an employee “flunks” this test and learns a valuable lesson in the process rather than respond to a real phishing email and expose your network.

You can also have a “stranger” walk into your office pretending to be a visitor and evaluate how your team handles the situation. Do they question it or assume that the person is OK and go back to whatever it was they were doing?

Take opportunities to not only protect, but verify that your protection measures are effective. You don’t need top-of-the-line IT protection if your company has limited financial resources. Develop a plan in which systems are updated on a regular basis and training and awareness is an integral part of your safety program. Costs have come down in recent years, so you should be able to find an option that is right for your business.

Insights Accounting & Consulting is brought to you by Kreischer Miller

Three financial improvements to grow your construction company

Financial reporting in the construction industry is often only as good as your last estimate. From the initial bid to ongoing measurement of costs and to the final pricing of change orders, estimates impact every aspect of a construction project.

Therefore, it’s critical for construction companies to handle all estimation issues properly to increase company profitability and provide management with quicker, more accurate estimates, says Michael S. Essenmacher, CPA, Director, Accounting and Assurance at Barnes Wendling CPAs.

Smart Business spoke with Essenmacher about the three things you can do to ensure more accurate financial reporting on construction project estimates.

1. Avoid burden rate estimation errors
One of the most common errors in contract estimates is incorrect overhead or burden rates. Most construction contractors are very efficient at allocating direct costs such as labor, materials and subcontract costs. However, one of the difficulties when maintaining an accurate burden rate is understanding what costs need to be included.

Burden rates are used to measure indirect contract costs such as payroll taxes, depreciation, insurance and repairs proportionately across contracts in progress. Maintaining an effective burden rate involves constantly monitoring and understanding the composition of indirect costs.

For example, construction companies must understand how changes in workers’ compensation expenses and unemployment taxes affect the payroll tax component of the burden rate. Workplace injuries, layoffs and hiring additional employees can all impact this figure.

Another example of changing indirect costs is equipment usage rates associated with depreciation from new fixed assets or significant repairs to older fixed assets. Construction contractors often assume their burden rate is consistent from year to year; ignoring indirect cost changes that can affect it.

Burden rates should be evaluated annually to maintain their accuracy. Doing so will lead to more informed cost structures on contract bids and improved accuracy of contract costs and estimated costs to finish contracts in progress.

2. Utilize work in progress reports to track financial performance
The next step is to utilize this gathered data within work in progress (WIP) reports to accurately track financial performance. Management should evaluate WIP reports on an ongoing basis to better understand the reasons for variances.

By evaluating WIP within a reasonable timeframe (monthly), information is more readily available from project managers and employees handling change orders.

The timely analysis of WIP reports will provide better estimates of the cost to complete the project and improved comparisons across multiple periods and against completed contracts.

When analyzed with different criteria, these comparisons can indicate contract inefficiencies among project managers, business lines or offices within the company. Accurate WIP reports enable management to increase cash flow within the company through improved billing of customers.

3. Timely billing improves contractor relationships
Timely billing enhances the relationship between contractors and contract managers. When both parties are in agreement regarding the performance of contract work, pay applications are approved and are more likely to be paid quickly by customers.

A quick turnaround of billing will help increase accounts receivable turnover and cash flow, reducing the necessity to rely on lines of credit. A positive cash flow strengthens working capital within construction contractors, and strong working capital and cash flow lead to elevated bonding capacity and the ability to sustain larger contract backlogs. All of these aspects improve the company’s overall financial health and increase its stability.

Developing and maintaining burden rates, minimizing overhead costs, effectively managing contracts and improving estimates within WIP reports allow for additional revenue opportunities from more contracts.

These steps also improve the efficiency and cost management of construction contracts through accurate estimates.

Insights Accounting & Consulting is brought to you by Barnes Wendling CPAs

Develop employees to improve your bottom line

To build teams that deliver results, the groundwork must be laid from the start. This, in part, requires a framework through which strategic hiring decisions can be made.

“The more consistent companies can map their core values to candidates’ motivators in the early stages, it will lead to better decision-making,” says Laura Rohde, director of Human Resources at Skoda Minotti.

After onboarding, it’s important to develop employees. This can be done through coaching, mentoring and individualized training programs.

“By focusing on the individual, employers can better engage employees, which in turn benefits the organization,” she says.

Smart Business spoke with Rohde about strategic hiring and leadership development, and how this impacts the bottom line.

What are the keys to creating a framework to make strategic hiring decisions?

A talent selection framework should incorporate behavioral-based interviews that are geared toward identifying and discovering the behaviors the company wants its employees to exhibit.

Motivational fit questions can be used to gauge candidates’ passion for the job and how well they would fit with the company culture. That means measuring personal motivators against the company’s core values. The Birkman Method®, an assessment tool, is one way to measure the strength of a candidate and his or her personal motivators.

What is the significance of coaching and development programs to an organization?

Employees find success through learning. Fostering a lifelong learning culture helps companies get better. By contributing to employees’ development, employees gain skills and knowledge they can invest back into the company.

The tenets of a good coaching and development program are always tied to individual needs. Strategically, through The Birkman Method®, employers can identify what employees need from the work environment and from colleagues. That information goes into a report that outlines how best to approach a person, and how his or her work should be organized. It’s in essence a cheat sheet for managers that gives them an idea of how a person is wired and how to coach and develop them.

Also, VAK (visual, auditory or kinesthetic) tests can determine the type of learner a person is so managers can create an effective approach to training.

How can companies keep employees motivated and wanting to make change?

Get employees involved and engaged. It’s important that they feel their voice is heard and their input is valued. Treating all employees as owners helps them feel invested in the company.

Consider holding monthly staff meetings at all levels and having open forums. At these meetings, employees should be encouraged to bring forward issues and brainstorm or problem solve to develop solutions for them.

Accessibility is also important. By knocking down barriers between employees and management, they can co-create positive change together.

Also, if someone comes onboard and could be better used somewhere other than his or her current role or department, consider moving that person to a role that can better utilize his or her strength.

What are the keys to developing leaders?

Developing leaders requires delegation, cross training and setting stretch goals, all of which can help motivate the right employees to take their careers to the next level.

Another key is communication. Bring these employees to meetings and on client visits to let them see the company from more of a global perspective.

Managers should be approachable. Make time for these employees. Have an open-door policy, or at least times when they can interface with management.

It’s also important to lead by example. Managers become role models that exemplify the desired behaviors of future leaders, which means they need the self-awareness to know how they come across to ensure there isn’t a disconnect.

A company’s people are its greatest assets. Invest in them. Great employees will deliver exceptional customer service that impacts your bottom line.

Insights Accounting is brought to you by Skoda Minotti

Potential U.S. corporate tax reform under the GOP

Both political parties agree that the U.S. needs dramatic tax reform in order to simplify our system and be more competitive in the global market. But that’s as far as the agreement goes.

“The general consensus is because you have one party in the House, Senate and as the president there is never a more likely time for this to happen. That’s not to say it’s not still without its challenges,” says Dave McClain, Tax Managing Director at BDO USA, LLP.

Almost every section in the Internal Revenue Code was created as an incentive for a specific purpose, group or special interest.

“Everybody has some skin in the game,” he says. “When you talk reform, it’s not only challenging things that Democrats have done, but it will be challenging bills that Republicans have introduced and passed over the years as well.”

But after years of talk, the momentum is gathering for something to possibly be passed this calendar year. When it could actually take affect, however, is not clear.

Smart Business spoke with McClain about what could happen to corporate taxes under the Trump administration.

What is wrong with the U.S. tax system as it operates today?

Not only is the U.S. tax code complex, it follows a worldwide tax system. Corporations are taxed on profits no matter where they are earned. There are ways to defer tax until the profit earned abroad is brought back into the U.S., but it’s still taxed. Other countries tax systems are territorial, where corporations are taxed only on profits earned in the country in which they operate.

The U.S. also has one of the higher corporate tax rates globally, which has even encouraged businesses to move overseas.

What changes are being proposed?

The GOP House Blueprint proposes reducing the corporate tax rate to 20 percent, switching to a territorial system and implementing border adjustments. These structural changes are an attempt to simplify and streamline the international tax rules and to encourage businesses to access ‘trapped cash’ overseas.

More specifically, the Blueprint seeks to move to a destination-basis tax system, where the tax jurisdiction of income follows the location of consumption rather than the location of production. Border adjustments effectively exempt exports from U.S. tax while taxing imports. In other words, it does not matter where a company is incorporated; sales to U.S. customers are taxed and sales to foreign customers are exempt, regardless of whether the taxpayer is foreign or domestic.

How likely is it that the reforms go through?

It’s too early to say. What’s being proposed could change several times between now and when it’s passed — and what ultimately gets passed may or may not look at all like what’s being proposed right now. Over the summer is probably when we’ll get a better idea if something truly is going to happen in calendar year 2017.

The idea is to lower corporate rates and broaden the tax base by eliminating deductions. It won’t be easy to balance this without the border tax adjustment, the most contentious piece. Challenges surround a border tax, but it’s also the biggest issue that people want to push through.

Globally, most countries have indirect taxes with some sort of border tax associated with them. Going to that type of system wouldn’t be out of the norm. The transition would be difficult, though, because while the U.S. might end up collecting more taxes, who pays would shift. Retail imports significantly more than it exports, so retailers would share in more of the tax liability in the new system, but industries such as aerospace would benefit because those corporations manufacture here and export globally.

What should business owners do in regards to this issue?

You can only plan for what you know. You have to operate within the rules as they exist today. That doesn’t mean business leaders and their advisers can’t look to what’s being proposed and try to position themselves should these reforms actually happen, but they don’t need to go through any major restructuring right now. It’s still an evolving conversation, but you do need to be paying attention. Your accountants can speak to you now and help you plan ahead.

Insights Accounting & Consulting is brought to you by BDO USA, LLP

Give yourself the best chance to succeed in your next M&A transaction

Over the last few years, many businesses have turned to mergers and acquisitions (M&A) to generate growth or enter new markets. However, if past performance is any indicator, a large percentage of these acquisitions will turn out to be failures.

Smart Business spoke with Christopher F. Meshginpoosh, Director at Kreischer Miller and a Certified M&A Advisor, to learn more about how companies can maximize the probability of success in M&A.

How do you define success in the context of M&A?
While there are a number of quantitative and qualitative measures of success in business, the one that cuts across all industries and geographic boundaries is return on investment. Unfortunately, numerous studies have shown that M&A returns usually fall well short of initial expectations and actually destroy more value than they create.

How can owners and executives increase the probability of providing a reasonable return on investment?
Recognize that M&A is just one of many capital allocation alternatives at your disposal. Building long-term value should involve the constant evaluation of all available uses of capital, including capital investments, share repurchases, mergers and acquisitions and joint ventures, among others.

In some cases, particularly when the M&A market is hot, investing capital in your plant may make more sense than buying a businesses at inflated prices. The best buyers act like great investors — they do not fall in love with any one idea, but employ a disciplined approach that involves looking at the potential return from all available alternatives. M&A may be the best way to maximize value at a given point in time, but you should carefully consider all other options.

What is the most common mistake you see?
Paying too much. The difference between a failed acquisition and a successful one often comes down to nothing more than timing. When the market is hot and your competitors are all buying businesses, the pressure to jump into the M&A frenzy can be immense.

However, that is exactly when you want to be the most cautious, because even a profitable target can destroy shareholder value if you pay too much for it. You have to constantly remind yourself that success will be measured based on your return.

If the purchase price is high because of competing offers, then the target may have to generate unreasonably high cash flows in order to provide an adequate return. Conversely, if you buy when the market is soft, you have much more margin for error. That is why it is no coincidence that the most successful acquirers are those that are willing to wait years for the right deal to emerge.

Assuming a company chooses to pursue an M&A strategy, how time-consuming is the process?
Ask almost anyone how well their first acquisition went and you are bound to get an earful.

Due diligence efforts alone can be all-consuming, requiring an assessment of financial trends, people, operations, customer relationships and intellectual property.

Additionally, you need to consider valuation, negotiate terms, develop integration plans for all major functions and develop communication plans for key stakeholders. Who handles all of this? Far too often, companies lean too much on outsiders for the lion’s share of the work. Don’t get the wrong idea — advisors can provide substantial value in the M&A process.

However, management teams should have enough bench strength to own the process from planning through post-merger integration, enough experience to understand the key value drivers and enough objectivity to make sure they close the right deal.

Insights Accounting & Consulting is brought to you by Kreischer Miller

Are you prepared for the changes to revenue recognition and leases?

“The Financial Accounting Standard Board (FASB) was busy during 2016. A total of 20 accounting updates and amendments were issued, and two of the 20 are either impacting our clients now or will so in the next couple of years,” says Seán N. Kilbane, a director of Assurance at BDO USA, LLP. “If our businesses aren’t talking about the board’s changes to revenue recognition and leases, they ought to.”

Smart Business spoke with Kilbane about changes to revenue recognition and leases.

What’s important for business owners to understand about revenue recognition?

The new revenue recognition standards will take effect in 2019 for most midsize companies, and next year for publicly traded businesses. No particular industry is immune from adopting the new standard, as FASB’s goal was to offer a greater level of comparability across all industries and to minimize differences in the way in which revenue is recognized.

For many businesses, this will impact the timing and pattern of revenue recognition. For others, especially where industry specific guidance was followed, the changes could be significant and will require careful planning.

The basic premise of the new standard is to record revenue when customers obtain control over the goods and services that are provided to them, rather than when simply ‘earned.’

The new standard requires companies to identify their customer contracts, and such contracts can take many forms. After figuring out what contracts they have, businesses must assess what distinct items they have to either deliver, produce or provide services for, and for which of those distinct deliverables the customer benefits from — either if sold on their own or in a combination with other deliverables, such as construction materials together with labor for a build out of space. Businesses then determine the price of the overall contract and allocate that price to each of those distinct deliverables. Once these performance obligations are satisfied, they can recognize the revenue.

Business leaders should familiarize themselves with the new standard and evaluate the impacts on each revenue stream. They should also be aware of trickle-down effects. Businesses need to ascertain what this may mean for complying with EBITDA and other financial performance-based covenants, the income tax implications and what effects this may have on their internal control environment.

The best advice in anticipation of these changes is to act now. Businesses need to consider the various transition methods that the FASB has prescribed, look into training for finance personnel and monitor any additional updates. Their financial experts can help assist all lines of business through this transition.

How are leases changing under FASB’s updates?

This mainly impacts lessees —  companies that lease property or equipment — but has less sweeping implications for lessors, such as landlords.

For small and midsize companies, beginning in 2020, lessees will be required to bring long-term leases onto their balance sheet, by recognizing the right to use the leased asset and establishing a liability to capture the present value of the future lease payments. For shorter termed leases, lessees can make a policy election to treat their leases similarly to how operating leases are currently accounted for — that is without capitalizing, and by recognizing expense evenly over the life of the lease agreement.

Each lease under the new code will need to be categorized as a financed or operating lease, depending on how much control is asserted over the asset now or will be at the end of the lease. This categorization matters, as it impacts the pattern of expense recognition and where to point cash flows in financial statements.

It’s important to be proactive, to develop a plan and consider the impacts with lenders and other stakeholders, especially since new assets and liabilities will be presented, which can significantly change a company’s financial ratios. Also, businesses should consider whether their software can handle the new complexities of lease accounting.

Again, the right advisers can help, regardless of complexity, with either an assessment of current system needs or with a new system implementation.

Insights Accounting & Consulting is brought to you by BDO USA, LLP

Normalized earnings can be a helpful tool to assess your business

Normalized earnings represent adjustments to a company’s earnings to remove the effects of nonrecurring items, such as one-time gains or losses, unusual items and the impact of seasonal or cyclical sales.

This calculation is often used to provide business owners, prospective buyers and others with a company’s true earnings and its repeatable stream of economic benefits, says Richard Snyder, CPA, Director of Audit & Accounting at Kreischer Miller.

Smart Business spoke with Snyder about the benefits of determining your normalized earnings.

How are normalized earnings calculated?
There are generally different types of adjustments to normalized earnings: Non-recurring gains, losses and discretionary expenses and adjustments for seasonality or cyclical sales cycles.

Non-recurring, one-time items may include expenses such as lawsuits, restructuring charges, discontinued business expenses, one-time repairs, natural disasters, the write-off of a note receivable and other abnormal expenses.

Non-recurring gains may include the sale of real estate or investments, insurance payouts or a settlement from a lawsuit. Discretionary expense adjustments may include, but are not limited to items such as salary or bonus adjustments, or adjustments for related party rents.

Often, owners of closely held businesses may pay themselves a salary which is not reflective of current market rates that would be paid if an outside person were hired to run the business. In situations where a company pays rent to a related party, the rents may not be reflective of the current market, which may require an adjustment to normalize.

Cyclical sales or seasonality are typically adjusted using a moving average over the number of periods in order to present normalized earnings.

What are some important things to know about normalized earnings?
Normalized earnings provide the ability to develop reasonable projections of a company’s future income-generating ability and can play an important role for owners and other stakeholders for a number of reasons. These can include buying or selling a business, the valuation of the business or evaluating a business against its industry peers.

Past performance is generally relied upon in order to develop an expectation for future earnings and cash flow. In the event of a sale or acquisition of a business, earnings from the past three to five years are analyzed.

As part of this review, a number of adjustments may be required in order to better estimate what is reasonably expected to occur in the future. The selling or acquisition of a business relies heavily on adjusted earnings and cash flow figures in the determination of the purchase price.

Consistent, reliable earnings and cash flows are important as this lends credibility to the financial recordkeeping and reporting process, which in turn provides a level comfort to all interested parties.

Valuation of a business takes a similar approach in which the valuator is looking for one-time, non-recurring items to ensure consistent financial reporting in the determination of a business’s value.

What does the process of normalizing earnings allow a company to do?
Normalizing earnings allows businesses the ability to compare themselves against their peers. Comparing operating results and other important metrics can assist a company in determining its strengths and weaknesses against its peers.

This in turn provides companies with an opportunity to improve their business by analyzing those strengths and weaknesses and developing an action plan to address them.

Normalizing earnings is a common practice used for multiple purposes. Reporting financial information adjusted for one-time items or discretionary expenses provides users of that information a more realistic picture of a company’s financial results and a more reliable tool with which to estimate future earnings.

This can lead to a better decision making process for owners and stakeholders, whether it is for a valuation of the business, a buy/sell situation regarding a business or evaluating one’s business against its peers.

Insights Accounting & Consulting is brought to you by Kreischer Miller

Manufacturers: Reinvest savings into your company to gain an advantage

The state of manufacturing in Northeast Ohio is economically cautious, according to Jon Shoop, CPA, principal at Skoda Minotti.

“Many manufacturers see that there are sales to be made and business to be had, but they’re hesitant to go out and spend on capital improvements or people,” he says.

Manufacturers in Northeast Ohio had a strong first half in 2016, but the second half tapered off, he says. Some of those businesses feel that the warm winter last year accelerated orders in the first half — orders that enabled construction starts, for instance — which in turn cannibalized orders from the second half.

“There has been more strategic and financial M&A buys,” Shoop says. “There is money to be spent and manufacturing is seen as a hot target. Buyers, including companies and private equity firms, are buying manufacturers and getting value out of those businesses. Owners of manufacturing companies that are approaching an exit and have groomed their business in preparation can expect a payday.”

He says there’s also a trend toward additive manufacturing, with the proliferation of 3-D printing shifting the focus away from piecework and low wages.

“The process lends itself to a more innovative environment than in China where the competitive advantage is low cost of production.”

Smart Business spoke with Shoop about the state of manufacturing, the industry’s challenges and its opportunities.

What challenges should manufacturers expect to face this year?

Some of the main challenges manufacturers face are sales competition, rising material costs and lack of available skilled labor.

Workforce continues to be a challenge, especially as reshoring — bringing jobs that had been outsourced to other countries back to the U.S. —  continues to be the trend. There are educators, associations and public entities that are working to provide solutions, but the response hasn’t been fast enough to outpace the problem.

Sales competition is another challenge that is directly related to the quality of a company’s innovation and product diversification models. Manufacturers must create opportunities in existing markets that are nontraditional to gain an edge in sales. For example, some manufacturers are doing contract manufacturing or manufacturing as a service in addition to their standard offerings. Some companies have begun taking, processing and shipping other manufacturers’ orders as a way to diversify business to create more sales opportunities.

Manufacturers are also contending with rising material costs, either through a rise in commodities prices or vendors raising prices. The reflex response is to improve processes to increase efficiency. But that approach, in the long term, isn’t sustainable. Instead, a cost-plus approach to pricing ensures manufacturers aren’t giving efficiencies away. The revenue gained through improving processes should then be reinvested in the company.

Why should manufacturers emphasize sales over cost savings?

Sales dollars are more impactful when reincorporated into the organization. A 1 percent sales price increase has been shown to improve earnings before interest and taxes (EBIT) by 10 percent. Manufacturers should focus on costs and find ways to reduce expenses, but they also need to focus on their sale price.

What is the relationship between price increases and market share and how can the two be balanced?

Reducing prices just to keep market share is a mistake as it will most likely have a negative impact. A price cut — let’s say a 3 percent reduction in sales price to hold the line and maintain market share — reduces profit by that same 3 percent. That’s a 30 percent reduction of profit on a 10 percent return, which would decimate profitability. Instead, consider removing other value-add items or services — ask for cash in 10 days rather than 30 or require customers to pay freight, for example.

Manufacturers should invest in people, training, capital equipment, technology and strategic acquisitions rather than compete to be the lowest-price option. Banks have money to lend, so put cash to use and look for tax credits or incentives to reduce out-of-pocket expenses on those investments.

Insights Accounting & Consulting is brought to you by Skoda Minotti

Keep your internal audit function running at peak performance

An internal audit, which provides insight and recommendations based on analyses and assessments of data and business processes, is a valuable tool. It helps organize and improve your company’s governance, risk management, management controls and strategic decision-making.

But what does it take to create a world-class internal audit function?

Smart Business spoke with Laurence Talley, managing director of Risk Advisory Services at BDO USA, LLP, about how to optimize your internal audit system.

What are the big internal audit problems? How can a company counteract these?

First, you might lack resources. It’s not a destination career path, and there can be high turnover. After internal auditors learn skills like negotiation or analytical thinking, they often move to new roles or another company. But the internal audit plan must continue, which stresses the remaining staff.

Progressive companies now plan for this turnover — and some even encourage it. They coordinate with HR to keep a pipeline of candidates. By monitoring turnover and prompting employees to move to other departments, they create a culture of shared risk management and governance. Employees carry their understanding out to the organization.

Another concern is ensuring your internal audit’s approaches and methodologies align with the business strategy and the risk that matters most. Largely because of technology, the speed and fluctuation of risk are more rapid. Once an internal audit plan is set, your risk — not just your internal controls — must be continually monitored. Your internal audit needs to be strategically positioned in order to see changes coming, so it can determine how to respond.

The best internal auditors monitor risk throughout the fiscal year, working with the business to understand where there is a high risk of exposure, especially with technology and data, and challenging the internal controls in order to minimize the hiccups.

Your internal audit department also naturally looks inward at your operations and client base, but global, political and economic influences bring risks, as well. When your internal audit department does its risk assessment, which drives the audit plan, it should be robust. It should look at everything, including external influences, regulations, changes to your competition/industry and technology advancements.

What framework and strategies do the best companies use?

COSO (Committee of Sponsoring Organizations of the Treadway Commission), which was revamped in 2013, is the gold standard for a robust and comprehensive internal audit plan. No matter what the size of your company or your internal audit team, the COSO 2013 model is a playbook for managing your risks.

Your company can also get objective ideas from its internal auditors to support the remediation of issues.

Internal auditors should have a seat at the strategic planning table. If you’re contemplating an acquisition or new product line, internal auditors can offer a valuable viewpoint, help head off additional exposure and see how the change fits into your current controls. When you implement a new enterprise resource planning system, for example, have internal auditors participate in the pre-implementation, even if it takes a little longer to get it up and running.

To optimize an already strong internal audit function, where should a company start?

Start by reviewing your audit charter and leadership’s expectations. You don’t want to compromise those mandates; there needs to be clarity as to what’s expected.

Once that’s aligned, it’s a matter of adding effectiveness and efficiency. A standardized approach to assessing risk, planning your audit, executing your audit and reporting the results inherently drives efficiency. But leveraging technology to increase reach without additional time or effort is the smartest way to optimize the process. Internal auditors can get visibility on emerging risk and keep pace with changes. Technology is able to monitor key indicators that demonstrate emerging or trending risks.

Again, it comes back to making everyone aware of risk. The more you have a culture of risk monitoring and managing with self-checks on the department level, close to the emerging issue, the better your company will be able to remediate that risk.

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