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.

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

The pros and cons of using debt to support your business

A business can finance its operations either through equity or debt.

Equity is cash paid into the business by investors who receive a share of the company, enabling them to receive a percentage of profits and appreciation in value. Conversely, debt is borrowing money from an outside source with the promise to return the principal, in addition to an agreed-upon interest level based on the risk being assumed, says Robert Olszewski, director at Kreischer Miller and leader of its distribution industry group.

“In a privately held company, investors have less ‘liquidity’ because the shares are not traded on the open market and a purchaser may be difficult to find,” Olszewski says. “This is one reason why successful and rapidly growing small businesses are under pressure by stockholders to ‘go public’ and thus create an easy way for investors to cash out.”

Smart Business spoke with Olszewski about how debt is interpreted by investors and what that means for your business.

What are the advantages of debt financing?
By borrowing from a financial institution or another source of funds, you are obligated to make the agreed-upon payments on time and to operate within specific financial covenants; this is the end of your obligation to the lender. A key advantage to debt is that you can run your business in accordance with your plan with limited outside interference.

How do owners maximize their return on investment?
Some leaders struggle with this concept early on, but over time, gain a better understanding of how it works. Simply put, if you have $5 million of equity invested in your business and the company generates $500,000 in profits, your return on equity is 10 percent.

Conversely, if you borrowed $2 million from the bank to invest elsewhere while maintaining $3 million in equity, your return on investment is now 16 percent. Granted there would be interest costs associated with the $2 million in debt. But you would still be ahead of the game at a 10 percent interest rate on the additional borrowing.

How do you know when enough is enough when it comes to debt?
Leverage ratios are often the measure of overall risk; debt-to-equity is the most common (total liabilities divided by shareholders equity). In general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations.

However, low debt-to-equity ratios may also indicate that a company is not taking advantage of the increased profits that financial leverage may bring.

Lenders and investors usually prefer low leverage ratios because the lenders’ interests are better protected in the event of a business decline and the shareholders are more likely to receive at least some of their original investment back in the event of a liquidation. This is a common reason why high leverage ratios may prevent a company from attracting additional capital.

What if traditional debt is not an available option?
This is risky and may indicate that an owner is going too far. There are two common forms of alternative financing; equity based and mezzanine (each coming at an embedded cost).

Equity financing involves selling shares of your company to interested investors. Investors may also provide mezzanine financing which are debt instruments provided at significant interest costs (based on risk) and a provision to convert debt to equity.

Leverage in business is normal. The pros and cons directly correlate to the amounts and types of obligations that you are willing to incur.

Insights Accounting & Consulting is brought to you by Kreischer Miller

How the restaurant industry’s sales are stacking up

Each quarter, BDO USA, LLP compiles the operating results of publicly traded restaurant companies in order to help restaurants benchmark. In its most recent report, same-store sales through the third quarter decreased, mainly due to increased competition and declining foot traffic.

“The Northeast Ohio market has seen a similar decrease in same-store sales as the national market,” says Adam Berebitsky, tax partner and co-leader of the National Restaurant Practice at BDO USA, LLP.

While BDO’s study uses publicly traded restaurant company information, Berebitsky believes the private sector probably saw a similar decrease in its same-store sales.

Smart Business spoke with Berebitsky about trends in the restaurant industry.

What’s going on with same-store restaurant sales and profit margins?

Publicly held restaurant companies saw same-store sales decreases of 0.1 percent through the third quarter. This deceleration may be attributed to the widening pricing gap between grocery stores and restaurants, and subsequent shifts in consumers’ attitudes toward dining out. Also during the third quarter, pending labor regulations fueled uncertainty around workforce compensation among restaurant operators.

The fast casual segment has fallen into this decline, which is different from the growth reported in fiscal year 2015. Chipotle’s 24.9 percent decrease, for example, works against the average as the brand strives to restore its reputation and customer base by dedicating dollars to marketing and offering more promotions.

The two public restaurant sectors still reporting positive same-store sales are the pizza segment, where Domino’s is leading the charge, and the quick-serve segment.

While same-store sales remain a concern, declining commodity costs is a reason for optimism, most notably higher beef supplies. Lower commodity prices can be a double-edged sword, though. The savings generated for restaurants are also available to consumers through less expensive groceries.

In this highly competitive market, restaurants are reluctant to raise prices to combat declining sales. Price increases also won’t overcome the reduced foot traffic.

Where do things stand with labor costs?

Labor costs increased across all segments for the third consecutive quarter — most significantly in the fast casual segment.

The recent election has quieted some fears about regulated labor costs, especially since President-elect Trump’s nominee for Secretary of Labor is fast-food executive Andrew Puzder and the new Department of Labor overtime rules are suspended as a result of a recent Texas court ruling.

Despite this, labor concerns still exist due to a possible localized minimum wage hike, low unemployment — which means restaurant owners may have to pay higher wages to find workers — and rising health insurance costs. Many restaurants will have to return to the drawing board to identify strategies for reducing labor costs.

How do you think the restaurant market will perform, looking ahead?

As we head into the new year with an increasingly saturated market and labor regulation uncertainty, restaurants need to be more creative, such as utilizing technology to drive sales and provide quicker, more efficient ways to deliver food to the consumers at either the restaurant or their homes.

Despite the results through the third quarter, restaurant valuations continue to be strong and many speakers at the November Restaurant Finance & Development Conference were bullish on the industry’s outlook. Economic conditions remain healthy and consumer confidence trends upward post-election, suggesting the restaurant sector may benefit. Investments in emerging brand concepts continue to be strong throughout the country.

Businesses need to use lessons learned from 2016 to adapt their strategies for 2017. By keeping their finger on the pulse of consumer preferences and behaviors, as well as the competitive landscape, restaurants can ensure they’re cooking up and delivering offerings that meet consumers’ — and investors’ — evolving needs.

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

Debt is a cheaper way to grow your business, when done the right way

Companies seeking to enter a new market, expand their business or make an acquisition would be wise to consider leverage to achieve their growth goals, says Brian J. Sharkey, director of Audit & Accounting at Kreischer Miller.

“Using leverage is an instant shot in the arm of capital,” Sharkey says. “If you go to a lender who is familiar with your company, you may be able to obtain the necessary capital to help achieve strategic goals and move on them quickly.

“Companies that choose to grow organically need to stockpile profits that would otherwise be given as a return to equity holders. They put it aside to build up capital and then use that internal cash flow to support the growth plan. It’s a slower process and in some ways, you’re sacrificing profit for growth.”

One of the keys to effectively using leverage as part of a growth plan is a strong relationship with your lender.

“Keep your lender abreast of the company’s performance and any significant changes,” Sharkey says. “Being proactive with your lender establishes a comfort level and gives you a little more leeway when something unexpected occurs.”

Smart Business spoke with Sharkey about what to consider when using leverage to grow your business.

What’s the best approach to take with a debt financing plan?
First and foremost, know the anticipated return on your investment. Typically, when a business obtains debt or another type of financing, it’s for a specific purpose. Most companies will have a plan for what they are trying to accomplish, but what many fail to do is quantify the anticipated return on investment that is expected to be created.

If you do the math and find that your investment return is greater than the cost of debt, it’s probably something you want to consider pursuing. If you don’t go through the exercise, you may be leaving a lot up to chance.

It is also critical to stress test your plan. What happens if you don’t meet sales obligations? What if your profits aren’t what you expect? It is important to run various scenarios and use the findings to make informed strategic decisions. It’s important to have a plan, but it’s also useful to have financial information to back it up.

Do you see any common mistakes when businesses take on debt?
Typically, it’s not a good idea to borrow on a long-term basis for short-term needs. Long-term financing should be lined up with long-term goals and initiatives. Financing tools such as a line of credit should be held for working capital needs like the financing of receivables or inventory on a short-term basis.

A good way to look at this is to line up leverage with the assets you’re acquiring so the debt service period matches the time period you expect to receive returns from the asset. Otherwise, if things turn sour, you could be obligated to make debt service payments before receiving the benefits from an acquisition or machinery purchased.

What’s another reason to consider leverage or debt financing?
The cost of debt is much cheaper than the cost of equity. If you can properly balance the leverage and equity, you can increase the overall profits and increase the return on equity.

For example, if you have $10 million of equity in your company and you’re making $1 million a year, that’s a 10 percent return on equity. But what if you went out and got $10 million of capital via debt? Now you have $20 million of capital in your company. You may be able to double your profits to $2 million and may only have to pay $500,000 of interest to the lender.

The end result is with the same $10 million of equity, you have $1.5 million of return coming to the equity holders. You can increase the value of your company as well as increase equity returns just by adding some leverage.

Insights Accounting & Consulting is brought to you by Kreischer Miller

A simple review of your financial affairs could make a big difference

As the end of the year approaches, investors should revisit their existing investments, estate documents and beneficiary designations.

“Challenge yourself to get your arms around your investment assets,” says Scott J. Swain, CPA, CFA, CFP®, a partner at Skoda Minotti. “Ensure you’re taking advantage of year-end tax opportunities, and check beneficiary designations and the progress of your investment strategies.”

Smart Business spoke with Swain about what investors should check for in a year-end review.

What should investors know about their existing investments as the year closes?

Investors may have unrealized capital losses that can be harvested before year’s end to offset realized capital gains earned during the year, or it may make more sense to wait to take those losses in January. Review your tax situation and see if you can execute a portfolio strategy to save some taxes.

Investors over the age of 70 should make sure they’ve made the required minimum distributions for any IRAs or retirement plans. And consider applying a portion of any year-end bonuses to a 401(k) or 403(b) plan to take full advantage of any match.

Anyone making sizable charitable contributions, anything over $5,000, should consider gifting appreciated stocks and bonds rather than cash. Gifting publicly traded positions with unrealized long-term gains is a way to avoid the associated tax and get the full value of the position in terms of a charitable deduction. And the charity won’t have to pay tax on those gains.

How are current IRS provisions affecting gifting to family members? Is that expected to change in the coming year?

A person can gift up to $14,000 to any one person. That can take the form of any kind of asset — cash, real estate, anything. Married couples could gift $28,000 to each child under these rules and avoid filing a gift tax return. Going above the $28,000 threshold eats into the lifetime gifting exemption, which is $5.45 million per person for 2016.

New IRS regulations will impact gifting of privately held businesses as the IRS attempts to eliminate the ‘discount’ from full market value that has been available in the past. Those considering gifting a business in the near future should contact their tax advisers as soon as possible to discuss the impact of these new regulations further.

Why should investors re-examine their estate documents?

An annual review of estate documents is a good habit to get into. The goal in estate planning is to ensure assets are passed on to your heirs as intended. On average, people update their estate documents every 20 years, and within that time, thoughts about how you’d like your assets to pass could have changed.

Besides wills and trusts, many people have also established a financial power of attorney, and have a living will and a health care power of attorney as part of their estate plan. All of those documents need to be updated more frequently to avoid problems when someone goes to use them. For example, if a person’s health care power of attorney hasn’t been updated in 20 years, health care providers will almost certainly balk at accepting it.

What should investors look for when reviewing asset titling and beneficiary designations?

These documents bypass a person’s will and estate documents based on these designations. Most list a spouse and children as beneficiaries. If that has changed, because of divorce, for instance, it’s important to make changes before you forget about it. Ensure beneficiary designations are current on 401(k)s, 403(b)s, IRAs, life insurance policies, annuities, deferred compensation, payable on death accounts, etc.

What might it be costing someone who doesn’t work with an adviser to manage his or her assets?

While people today are more empowered to manage their retirement, they tend to neglect their portfolios, often because no one is holding them accountable for it. Having an adviser forces an investor to stay active. Also, people who do it themselves often can be too extreme in their portfolio allocations. A 20 to 30 percent loss in a portfolio due to an overaggressive allocation is devastating if it happens near or during retirement. A financial adviser can help investors hone in on meeting long-term cash flow needs while reducing risk to appropriate levels.

Financial and estate planning is an ongoing process. Spend the time needed each year to get the most out of it.

Insights Accounting & Consulting is brought to you by Skoda Minotti

The missing piece to building employee bench strength might be you

If your company has trouble hiring, developing and deploying talent — building bench strength — the problem might lie with you, the business owner. So, before you point fingers and lament about the talent shortage, look in the mirror.

“In an ideal world, the business owner is fully engaged in designing, developing and nurturing a strategic talent management system,” says Stacy Feiner, business psychologist and management consultant at BDO USA, LLP.

Business owners need to know their people as well as they know their numbers. They have a responsibility and the privilege to define the core expectations they want in their employees’ behavior and performance.

When an owner is detached from talent management — defining the expectations and thus the processes to get to those expectations met — the culture may unwittingly become a reflection of their worst traits, Feiner says. Long-standing distraction from shaping your culture can lead to neglect, and neglected environments will result in a slow decline, at best, or create organizational injustices like ignoring internal conflicts or undermining employee attempts to add value.

Smart Business spoke with Feiner about the mistakes business owners make and how they can overcome those to strategically build bench strength.

Where do business owners falter when it comes to talent management?

Many business owners see talent management processes and capabilities in isolation. They look at recruiting as a transaction, a cost and sometimes as a necessary evil. In contrast, succession planning is viewed as a strategic initiative that is supported with a budget and encouraged by the board. But really, succession planning and recruiting are different sides of the same coin.

Just think about professional sports teams — they don’t outsource recruiting because it’s a critical capability. Ultimately, people drive the numbers. That’s where your focus should be, even though human dynamics are challenging and not all business owners are interested or good at managing them.

Another concern is when business owners don’t have a mechanism to evaluate talent across their enterprise. This intelligence is already there; you just need to gather, package and translate it for employee development and succession planning. Think about how much easier it is to build bench strength with a clear picture of your current talent’s skills, potential, tendencies and temperament. People, generally, change jobs 14 times throughout their career, so why shouldn’t you leverage those changes? If your company is growing, the natural indication is to look out, rather than at top performers inside the business.

Also, once you’ve evaluated your talent, there needs to be a method for providing honest feedback on performance.

How can business owners recognize if they’re detached from their talent management practices?

The signs of detachment are pretty straightforward: not having a budget for talent management; holding a view that the activities of human resources and talent are an expense; and pushing talent management off to HR, without giving enough vision, insight or instruction.

What other critical elements help your company build bench strength?

It’s a mindset. Part of a business owner’s job is to shape the culture that in turn nurtures talent. It’s not HR’s responsibility to manage talent; HR must facilitate the owner’s talent initiatives and directives. It is HR’s job to partner with managers, so that together they can manage and meet employee expectations.

In the early 1980s, General Electric’s Jack Welch popularized the concept of talent management, and a disciplined system, that trickled down to the middle market. The middle market, however, wasn’t nearly as successful at developing culture and adaptive talent. What got lost in translation is that it wasn’t Welch’s system that created the success; it was that he used his philosophy.

Each business owner must define his or her own philosophy about people, in order to create the mechanisms and an integrated process to accomplish and achieve those expectations. You must be involved. And once you become engaged, it will create its own momentum.

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

A proactive approach is best when considering your company’s future

It’s not a question of if a business owner will exit his or her business, but more a question of when, says Mark Metzler, a director and Certified Exit Planning Adviser (CEPA) at Kreischer Miller. A recent Exit Planning Institute (EPI) survey indicates 76 percent of business owners plan to transition over the next 10 years, and 48 percent in the next five years.

These projections are driven by the fact that the first baby boomers turned 65 in 2011 and 10,000 more boomers turn 65 every day, with the youngest members of this group now in their early 50s.

This generation owns 63 percent of the private businesses in the United States, and their businesses represent 80 to 90 percent of their personal net worth. Soon, however, they’ll need to consider the next step for their respective businesses.

Smart Business spoke with Metzler about the value of developing an exit strategy for this inevitable outcome.

If an owner isn’t looking to sell, why is an exit strategy important?
Every business will ultimately face the issue of the owner’s exit. It is therefore critical to have an effective transition or liquidity plan in place.

Exit planning is a business strategy for owners to maximize enterprise value while enabling the conversion of ownership into personal freedom and peace of mind. In Peter Christman’s book, “The Master Plan,” he compares a successful exit strategy to a three-legged stool. Each leg is critically important.

The first leg is maximizing the value of the business; the second leg ensures that the business owner is personally and financially prepared; and the third leg ensures that the owner has planned for life after the business.

What are the exit options available to a business owner?
There are two general categories for private ownership transition: An inside transition or an outside exit.

An inside transition comprises the following types:

  An intergenerational transfer is a transfer of business stock to direct heirs, usually children. Approximately 50 percent of business owners want to exercise this option, but in reality, only about 30 percent do so. This option is often an issue of estate planning rather than structuring a transaction. An advantage to this option is business legacy preservation.

  In a management buyout, the owner sells all or part of the business to its management team. Management uses the assets of the business to finance a significant portion of the purchase price, with the owner often providing additional financing. This option provides for management continuity, but it also introduces financing risk to the seller.

  A sale to existing partners is typically less disruptive, but the success of the transition is closely linked to the existence and quality of a buy-sell agreement.

■  A sale to employees may be accomplished through an ESOP, where the company uses borrowed funds to acquire shares from the owner.

Conversely, an outside exit may entail:

  A sale to a third party, where the owner sells the business to a strategic buyer, a financial buyer or private equity group through a negotiated sale, controlled auction or unsolicited offer. This is typically a long process, but may result in the highest price.

  A recapitalization or refinance involves finding new ways to fund the company’s balance sheet. A new lender or equity investor (minority or majority position) is brought in as a partner. This may permit the owner a partial exit, while providing growth capital.

  An initial public offering or the expression “going public” involves the registration and sale of company securities (common or preferred stock or bonds) to the general public — a costly option not practicable for the majority of privately owned businesses.

  In an orderly liquidation, the asset value is greater than the value of the business as a going concern. The business is shut down and its assets are sold.

An effective exit strategy begins long before an actual exit, as maximum value is optimized when an exit is proactive rather than reactive. Early planning provides knowledge that the business owner, not the potential buyer, will drive the exit process to achieve personal goals and objectives.

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