Demystifying Industry 4.0 for business owners and manufacturers

The term Industry 4.0 continues to mystify many business owners, but it’s less complicated than it sounds.

“People think it’s a large, complex and expensive transformation that only big companies can do. That’s not the case at all,” says Eskander Yavar, national leader of Management & Technology Advisory Services at BDO USA, LLP.

While U.S. companies are behind Europe and Asia on this, the wave is starting to break as everything becomes more digitized.

“There could be a point, in the next five to 10 years, where if you’re not doing it, you’re slowly dying,” he says.

Smart Business spoke with Yavar about what Industry 4.0 is, examples of how it has helped companies and how to get started.

What exactly is Industry 4.0?

It refers to the fourth industrial revolution. The first revolution was the advent of steam and water power to drive machinery in factories, which enabled less manual effort in the 18th century. The second revolution was how electricity changed the factory floor, which brought globalization and mass production in the 19th century. The third revolution was the introduction of computers, the internet and automation. This next revolution combines artificial intelligence (AI), data, the cloud — which is just off-site computers — 3D printing, etc.

It’s not a total transformation that’s cost intensive. It’s not reinventing every company. It’s about understanding the technology and the availability of data and connectivity through internet-enabled devices, so new technologies can solve a business problem. For example, you can improve on-time delivery by managing the end-to-end supply chain process through data, an analytics platform, radio-frequency identification tags and sensors.

Industry 4.0, and its ability to deliver data about demand-curves, buying behaviors and other critical patterns and predictions, applies to all manufacturers, from process-oriented and repetitive, to build-to-order. It enables them to gather greater business intelligence and develop customizable products on a mass scale. It accelerates the decision-making process and improves speed to market.

What are some examples of how Industry 4.0 can drive business results?

One manufacturer makes traffic signal preemption hardware so public safety and emergency vehicles can change red lights. It historically wouldn’t come back to customers unless it was time to service or upgrade that hardware. This manufacturer noticed its network threw off data about traffic conditions, how many times a vehicle caught a green light and other metrics. The company took that data and built an analytics platform in the cloud. Then, it sold the data in its desired state for compliance reporting to generate monthly revenue.

In another example, a transportation company had cargo ships going off course during their auto-pilot controlled routes. Because of the anomalies, ships were late and fuel costs rose. The amount of data that needed to be crunched to identify the issue was on such a large scale that the company used an AI algorithm to analyze the data to discover where anomalies were occurring. Then, the company implemented sensors on those ships, so it could autocorrect the errors as they were happening.

How should businesses get started on this?

Do a quick assessment of your technology, processes and connectivity, from a maturity perspective, to ensure the environment is right to introduce something different. Then, look for a use-case — a small proof of concept project — so you can get a quick win with better operational and financial results. Perhaps, it’s tackling a through-put at a certain point on the shop floor by adding sensors and analyzing that data. Then, over time, as you prove out every use case, you end up with larger upside.

Some businesses are already doing this, but don’t call it Industry 4.0. There are a lot of options, too: everything from a fully integrated digitized environment throughout the organization, to systems you don’t have to pay for. However, remember that while it involves technology, data and cloud, it’s not an IT project. It involves change for people and technology. The CIO shouldn’t be driving the transformation; it’s the operations or plant manager who understands inefficiencies in your environment, with executive team support.

Insights Accounting is brought to you by BDO USA, LLP

Budgeting, forecasting for a business and how it impacts personal finances

The personal lives of business owners, especially those with smaller companies, are intertwined with their business as long as it’s in existence. It’s a means of support for family expenses and their lifestyle.

Good budgeting and forecasting for business owners and their companies are critical to achieving the goals of each.

“A lot goes in to budgeting and forecasting, but when the business fiscal year ends, it’s a brand new ball game. Questions need to be answered before it begins,” says Michael Van Himbergen, CFP®, a financial advisor at Skoda Minotti.

“Review your financial situation and the financial situation of your business annually to make sure any obstacles — anticipated or otherwise — are handled before the end of the year so they don’t become roadblocks.”

Smart Business spoke with Van Himbergen about what to include in annual financial reviews and why they’re important.

What are the major considerations business owners should make as they budget and forecast?
Every goal needs a timeline, whether short- or long-term. Consider inflationary factors — the longer the timeline to achieve the goal, the greater the impact of inflation — and establish a target rate of return for each goal.

Make sure you’re paying yourself first out of business revenue. Calculate that as an expense and build it into the budget every year.

Establish a retirement plan for yourself and your employees if you haven’t already. There are a number of factors that determine what type of plan is best to implement, such as the number of employees, their average age, employer and/or employee contributions, to name a few.

If you want to cover college expenses for your children, the longer you wait, the more it costs. Families need to save $500 to $600 per month (per child) from the time their child is born to get them through four years of an in-state public university.

However, take care of yourself first to make sure you’re on track for retirement before funding for a child’s education. Children will have their entire productive lives to pay back student loans. You can always help out down the road.

Also, don’t forget to plan for weddings, big vacations and any other major purchases, accordingly. And it’s always prudent to have three to six months of monthly living expenses to cover an emergency.

How frequently should business owners review their business and personal finances?
Every year. Is your plan doing what it’s supposed to? Review the company 401(k) with employees. Is participation low? If so, determine the reason they’re not participating and educate employees on the benefits of the plan.

Always review income projections. A cash flow analysis will show you whether income is stable or fluctuating.

Review personal investments at least annually unless there are significant changes that would affect longer-term planning. If that’s the case, talk to your financial advisor/accountant to determine how that life-altering event could affect your long-term financial goals.

What, generally, are some ways to adjust to the new financial realities that follow a life-changing event?
Changing jobs, death or disability, death or disability of a partner or a key employee, having children, getting married or divorced are common life-changing events. When these events happen, it’s important to determine how they impact your financial plan.

Any of these can affect cost of living, the level and type of insurance protection that’s prudent, and how much money is available to save and spend. Regardless of what’s happened, it’s important to stick to a financial plan and make adjustments as needed, rather than stop saving altogether.

Unexpected aside, define your goals to determine the level of risk that’s prudent given your situation and the goal you’re trying to obtain. Review your circumstances at least annually with your financial advisor, both in terms of what’s going on in your life and in your finances, and you should have no trouble achieving your goals.

Insights Accounting is brought to you by Skoda Minotti.

Tips on identifying and reporting fraud in your organization

Fraud happens in businesses of all types, sizes and levels of sophistication. Though it can occur at any level of an organization, fraud more frequently happens at the management level or above. A 2014 report by the Association of Certified Fraud Examiners (ACFE) found that 36 percent of those who committed fraud were mid-level managers. Most were male and 87 percent were first-time offenders.

“Upper-level employees are more likely to be entrusted with sensitive information and may be able to override controls,” says J.W.Wilson, CPA, a partner in accounting and auditing services at Clarus Partners. “However, having a profile of a common perpetrator isn’t enough for an organization to stop fraud.”

Smart Business spoke with Wilson about fraud, its effect and what organizations can do to detect and mitigate it.

What are the more common types of fraud and what can they cost an organization?

There are two categories of fraud that are most common: misappropriation of assets and misstatement of financial statements. Asset misappropriation is a scheme through which employees steal or misuse an organization’s resources — for instance, false billing, inflated expense reports or outright theft of company cash. Misappropriation of assets is the most common, but it’s the least costly, averaging around $130,000 per loss.

Financial statement fraud is a scheme through which employees intentionally cause a misstatement or omission of material information in the organization’s financial statements. That could mean recording fictitious revenues, understating expenses or artificially inflating assets. Though financial statement fraud is the least common type of fraud, it’s the most costly, averaging $1 million per loss.

In general, fraud costs businesses in the U.S. billions of dollars each year. Typical acts of fraud costs businesses between $10,000 and $500,000. But in addition to costing businesses money, fraud also hurts productivity and company morale. Fraud can damage the reputation and customer relationships of the business, which can take significant time and energy to repair.

How is fraud typically detected?

Most often fraud is detected by an employee of the organization who then reports the fraud to someone internally.

Because staffers are most likely to identify and report fraud, it’s a good idea to put in place a fraud hotline or reporting system. In making employees aware of the hotline, consider communicating to whistleblowers that they will be protected from any reprisal, and that they could earn a financial reward if they’re willing and able to give useful information to law enforcement.

What are internal control reviews?

An internal control review is an overall assessment of the internal control system and the adequacy of that system to address the risks of the organization. They can highlight weaknesses in a company’s internal control structure or expose processes that could be strengthened to maximize efficiency. Detailed recommendations would be given to help mitigate risk or strengthen areas of identified weakness.

Most often, a company’s board, the owner or CFO requests internal control reviews. But it’s a good idea to perform a review every three to five years or more often if there is significant change in the company.

What should companies do once they have the results of their internal control review?

Management should work to implement the recommendations pulled from the findings of the internal control review and ensure that they are in place. Going forward, management should regularly communicate reminders of policies and procedures to the company, and periodically review the procedures and check that they are consistently being followed.

Research by the ACFE indicates that the typical organization loses 5 percent of revenues each year to fraud. While that 5 percent is certainly a chilling average, consider that the median losses from fraud for businesses with less than 100 employees are around $147,000. A loss of that size could be devastating for a midsize business.

Companies should understand that fraud could happen anywhere. Strong internal control policies and procedures are the best way to help minimize this risk.

Insights Accounting is brought to you by Clarus Partners

Oversight is needed to mitigate occupational fraud

Business owners, board members and other key stakeholders should give more consideration to what their organization is doing to prevent fraud, says Laurie A. Gatten, CPA, CFE, a director at Barnes Wendling CPAs.

“It’s concerning when I begin initial discussions with owners or other key stakeholders regarding internal controls, and when I ask them how they identify risks of fraud and what measures are put into place to mitigate those risks, the answer returned is, ‘That’s why you’re here as our auditor,’” she says.

Smart Business spoke with Gatten about occupational fraud and the internal controls that can mitigate it.

What is occupational fraud and what forms does it typically take?
Occupational fraud is the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of an organization’s resources or assets. It can be as simple as theft of company supplies or as complex as sophisticated financial statement fraud or corruption.

Asset misappropriation, corruption, and financial statement fraud are three types of occupational fraud. Asset misappropriation is by far the most common, but the least costly with a median loss of $114,000. The least common type of scheme, but most costly, is financial statement fraud with a median loss of $800,000.

What are the signs that fraud is occurring?
In most cases, fraudsters display at least one behavioral red flag and sometimes they exhibit multiple red flags.

The six most common red flags are:
  Living beyond their means.
  Financial difficulties.
  Unusually close association with vendors or customers.
  Control issues and an unwillingness to share duties.
  Divorce or family problems.
  A ‘wheeler-dealer’ attitude.
The leading detection methods are tips from employees or others, internal audit, and management review and oversight. More than half of all tips are provided by employees, but tips can also come from people outside of the organization, such as customers, vendors, and competitors.

What should happen once fraud is detected?
Once fraud is suspected or determined to have occurred, the perpetrator should be immediately removed from his or her position. The company should consult legal counsel and a certified fraud examiner. The attorney will assist on human resource and other legal matters, while the certified fraud examiner can quantify the losses, present investigation findings, and assist in developing proper controls to deter future fraud.

What steps can companies take to mitigate occupational fraud?
The first step an organization should take is actually implementing a fraud mitigation strategy. It’s really important for everyone to understand that management is responsible for implementing a sound internal control structure. While having an external audit is one way to measure a certain amount of effectiveness of a fraud mitigation strategy, the auditors cannot be part of a company’s internal control structure.

How can an organization test its fraud mitigation strategy to ensure it’s effective?
The best way to test the effectiveness of a fraud mitigation strategy is to have an ongoing monitoring process in place to evaluate it.

There are several measures to incorporate into a monitoring process, but most important are:
  Establishing a third-party hotline where suspicious activity can be reported without reprisal. Ensure all employees are aware it exists and know how to access it.
  Communicating anti-kickback policies to vendors, customers, and other outside parties.
  Jobs rotations, mandatory vacations, and determining if proper segregation of duties is in place.
Everyone in an organization is busy and it is easy to let certain internal controls go by the wayside. Continuous monitoring is key to ensuring the internal controls structure remains strong and is effective.

Insights Accounting is brought to you by Barnes Wendling CPAs

How to navigate the state sales tax landscape after the Wayfair decision

As e-commerce grows, states have become increasingly unhappy with how sales and use taxes are collected on remote retailers. A recent U.S. Supreme Court decision, South Dakota v. Wayfair Inc., however, dramatically changed the landscape for sales tax nexus, and the obligation to file and report taxes.

“It’s not Armageddon, but you may need to start filing in a handful or more states in the coming years,” says Mike Feiszli, managing director of state and local tax at BDO USA, LLP.

Smart Business spoke with Feiszli about what’s next for companies.

What’s the background on the Wayfair case?

Nearly 30 states created non-standardized statutes with economic nexus standards for sales tax. They sought to get around the nexus standard that a remote seller needs a substantial physical presence within the state to be subject to that state’s sales tax laws and reporting requirements, which the Supreme Court reaffirmed with the 1992 case, Quill v. North Dakota.

In 2016, South Dakota decided that a retailer that sells $100,000 of tangible personal property or services, or completes 200 transactions, has enough business activity to be subject to its sales tax law. The law was challenged by Wayfair and two other internet sellers in the South Dakota courts, with the lower level courts holding for Wayfair, due to the Supreme Court precedent. The Supreme Court was petitioned by the state and decided in June, 5-4, in favor of the state. It reversed Quill, finding that physical presence is an incorrect interpretation of the commerce clause and isn’t required for substantial nexus. It didn’t define what the nexus standard should be — leaving that to a stalled Congress — but it does consider South Dakota’s economic standard to be reasonable.

Have other states reacted yet?

Some states already had standards similar to South Dakota, and many of those became effective over the summer. About a dozen other laws will become effective soon. If a state had an economic nexus standard prior to Wayfair, the Supreme Court didn’t encourage retroactive enforcement. A few states, Ohio and California, for example, have higher nexus limits than South Dakota, while Pennsylvania has a nexus standard of $10,000. Many states, including Ohio, will likely start aligning more closely with South Dakota’s law.

What does this mean for businesses?

To any business owner not currently registered in multiple jurisdictions in the U.S., be aware that the landscape has changed. It’s no longer a matter of whether you have a salesperson or warehouse in a jurisdiction. If you have a certain amount of sales or transactions, states probably have, or will have soon, a law in place that will require you to register and start reporting sales and charging sales tax.

If your company believes it only has exempt sales or that because it only provides services, Wayfair won’t affect its business, that’s not necessarily the case. States will look at gross receipts that are sold into the state and expect you to register once you hit a threshold. You’ll need, at a minimum, to begin filing returns and reporting sales activity. You will also need to document exempt sales and keep exemption or resale certificates, while remembering that state’s rules vary on exemptions as well as acceptable documentation. If proper documentation isn’t kept and you’re audited, those sales could become invalidated and you as the seller may be on the hook for tax that likely should have been the purchaser’s burden.

There will certainly be a compliance cost to the court’s decision.

So, what needs to occur now? You need to do a self-analysis. States won’t immediately know you’re over because they’re not geared up for this change either — as much as they wanted this decision. However, they can and will eventually find out through audits of the purchases of your customers in their state and by cooperating with other states or governmental agencies.

Your tax adviser can help you determine the pressure points, the aggressive states, who is likely to be auditing companies soon and who is not. It’s like any business decision — go through the analysis, determine where you have issues and then decide on a plan that fits your risk tolerance and budget.

What else is important to know about the Wayfair’s long-term impact?

There are many unanswered questions, like how the decision affects international business. At some point, these cost burdens will likely be reflected in prices, and brick and mortar stores may find themselves on a more level playing field with internet businesses. As tax laws change, you’ll also want to keep an eye on whether this affects income tax or other state and local tax compliance in other jurisdictions.

Insights Accounting is brought to you by BDO USA, LLP

The new revenue recognition standard: Don’t try this without a safety net

Soon, it will be easier for users of financial statements to compare companies. But as this new revenue recognition standard comes on line, there may be some growing pains for businesses.

George Pickard, CPA, MSA, principal in the Audit and Accounting Service Department at Ciuni & Panichi, says the new revenue recognition standard is a joint project between the Financial Accounting Standards Board, that establishes financial accounting and reporting standards for entities following U.S. Generally Accepted Accounting Principles (GAAP), and the International Accounting Standards Board, which establishes such standards for entities following international financial reporting standards or IFRS.

Smart Business spoke with Pickard about the new revenue recognition standard and what business leaders need to know.

What changes under the new standard?

It gives everyone core accounting rules for recognizing revenue when they enter into contracts with customers to provide goods or services, so there’s better comparability across entities, industries, jurisdictions and capital markets. It makes it easier to analyze a company through its financial statements and provides more disclosure for users of financial statements.

Companies will use a five-step process for recognizing revenue:

1. Identify all customer contracts to provide goods or services, whether written, oral or implied by customary business practices.
2. Define the performance obligation(s) within that contract. Are there multiple steps with different deliverables?
3. Determine the transaction price.
4. Allocate the transaction price across the different performance obligations.
5. Recognize revenue as each performance obligation is satisfied.

Many companies will recognize revenue sooner; before they might have recognized revenue upon completion of the contract.

When does the new revenue recognition go into effect? Are there exemptions?

Public entities, certain not-for-profits and certain benefit plans are implementing it for the 2018 calendar year — if they have not already done so. For all other entities, it will be effective for 2019 calendar year items.

Transactions that follow other standards are exempted. Examples include lease contracts, insurance contracts, financial instruments and guarantees.

How should business leaders act?

Even private companies should look at this now. Encourage your CFO and accounting department to be proactive and ask for help. Get your system up early, so it can capture the information you’ll need for decision-making or the different disclosures. That way, you’re not rushing around or incurring higher costs than necessary. Also, this is retroactive. If your 2019 reports compare to the previous year, you’ll have to restate the 2018 numbers to comply with the new rules.

Identify all of your revenue streams and contracts to see how things might change. Your human resources and/or IT department may need to get involved. In addition, look at your loan covenants and grants to determine if any reporting obligations are tied to revenue. You don’t want to trip a covenant and then start having conversations with your bank.

Where will biggest obstacles occur?

You may need to change your systems, which could be time consuming and costly. It may not just be your accounting system, but also the system, let’s say, on your manufacturing floor.

Of the five steps, determining the transaction price will be the most difficult piece. Do you have variable consideration, such as a bonus for early completion? If so, it may need to be recognized earlier. Are you getting paid in non-cash? For items like stock, when do you recognize it and how much should it be valued at? Could there be a financing component? If you’re not going to be paid until two years down the road, is that interest income? Do you give discounts or rebates and how will those be considered?

Recognize the issues and start having conversations with your bank, your accountant and internally. You may decide to simplify your contracts. You may need to change your bonus policy if it’s tied to revenue. It will take time to adjust, so the sooner you start, the better.

Insights Accounting is brought to you by Ciuni & Panichi, Inc.

How business is made better with a strong accountant relationship

While very few businesses operate without tapping into the services of an accountant in some shape or form, some businesses aren’t using the relationship they have with their accountants to the fullest.

“Some business owners might just go to their accountant for tax advice, but what they don’t realize is that they could use them for much more,” says Nancy Supowit, director at Clarus Partners.

She says accountants are trusted business advisers and many business owners talk regularly with their accountants regarding issues that range from strategic planning, purchasing real estate, entering a new market or estate planning. Others, however, might not think to reach out and get advice from their CPA.

Smart Business spoke with Supowit about how business owners can get the most out of their relationship with an accountant.

What issues might arise if business owners don’t regularly engage their accountant?

Some businesses don’t keep good financial records during the year. That means the accountant gets books at tax time that are in bad shape, so it takes a lot more effort at the end of the year to sort out the information. That should be a concern for business owners, not just because it means they’re paying their accountants for more billable hours, but because they’re using poor or incomplete information during the year; and basing decisions on what is likely an inaccurate picture of the business’s situation.

Undertaking debt financing or relocating without first talking to an accountant could lead to a non-optimal decision. Had the idea been run past an accountant, he or she could have helped identify the best type of debt for the situation, or find a tax offset that would reduce the cost of a move.

What is it business owners might misunderstand about their relationship with their accountant?

There are different types of accountants for different needs. Sometimes knowing which type of accountant can address specific issues is pretty clear — for instance, if a company has a tax issue or a tax filing need, it should go to an accounting firm that has expertise in tax. However, what might go unrecognized is that accountants offer other services and specialize in many areas of expertise that could benefit a business.

Business owners’ professional and personal lives are commingled. So as important as it is to keep an accountant informed about what’s happening in a business, it’s equally important that the accountant knows what’s happening in an owner’s personal life. For instance, an accountant should be informed if there is a change in marital status as it could have a significant impact on the business or the estate. An accountant can also be a valuable adviser when it comes to retirement and succession planning.

What does a good relationship with an accountant look like?

Ultimately, the tone and frequency of conversations with an accountant are up to the business owner. While a good accountant will check in and ask questions to find out what’s going on, it’s up to the business owner to make the time for that conversation.

At a minimum, business owners should talk with their accountant at tax time about what’s happening in the business — is it expanding, contracting, changing locations, planning to acquire another company? It’s also a good time to update the accountant on any personal life changes.

Though talking with their accountant at tax time is important, it shouldn’t be the only conversation of the year. Year-round expert advice could prove valuable if implemented.

Business owners should strive to have a healthy, ongoing relationship with their accountant, who in turn should genuinely be interested in the state of things and work to understand as much as possible about the business. The comfort level should be such that the business owner feels welcome and free to talk. What form those conversations take — coffee each week, a quarterly call — is up to the business owner.

Insights Accounting is brought to you by Clarus Partners

Ruling brings major change to out-of-state sales tax collection

For many years, businesses had to have physical presence or nexus in a state to be legally required to collect and remit sales tax on transactions. E-commerce has essentially skirted that law and states have argued that they’re losing out on tax revenue they’re due. They challenged the court cases that set the physical presence standard — Quill Corp. v. North Dakota and National Bellas Hess v. Department of Revenue of Illinois — to little avail. Finally, with the recent South Dakota v. Wayfair Inc. decision, states have gotten the ruling they were hoping for. And it means significant changes for businesses that do out-of-state business, whether online or not.

Smart Business spoke with Nicholas Schatte, tax manager at Clarus Partners, about the Wayfair decision and how it affects businesses of all types and sizes.

What is the decision the Supreme Court reached in the Wayfair case?

The Supreme Court, in a 5-4 decision, overruled the standards set forth in Quill and Bellas Hess. Now, a physical presence is no longer a prerequisite for states to compel a business to collect and remit sales tax. All applicable transactions can be taxed.

As it stands, the Supreme Court sent the decision back to South Dakota’s Supreme Court to be evaluated for any reason that it might be unconstitutional. It’s expected that the law will be found constitutional and states will implement their laws prospectively, most likely between July 1, 2018 and January 1, 2019, but some states may attempt to collect the tax retroactively.

How does the decision affect businesses?

While much of the attention is focused on online retailers, it’s going to impact any business selling products into a state where the business isn’t currently collecting tax, such as wholesalers and manufacturers. Businesses will soon have an obligation to register with states’ departments of revenue, and start collecting and remitting sales tax. It will require businesses to collect sales tax in a lot more states than they are currently.

Brick-and-mortar businesses that also transact with out-of-state customers through a complementary e-commerce portal should pay close attention. They might not have concerned themselves with collecting sales tax on those transactions, but will need a mechanism in place to do so now.

Some businesses might not have software that’s sophisticated enough to comply with all states’ tax laws. Businesses previously could collect tax at whatever rate was imposed where the store was located. Now they’ll need to know the rate and tax treatments for potentially 45 states and numerous local jurisdictions, which is difficult and costly to do manually.

Even if businesses aren’t making taxable sales, they still have documentation requirements to prove that their sales aren’t taxable in a state. Legislation in some states might require businesses to file if they have a certain amount in sales in that state, not just taxable sales, and may be compelled to register and prove that they had no obligation to collect tax. That complicates businesses’ record keeping and adds to their administrative requirements. Other states require that sellers collect tax or report untaxed sales made in the state to both the purchaser and the tax authority. Some impose substantial penalties for failing to file the reports or collect the tax.

What should affected businesses do now?

As soon as possible, businesses need to analyze where they’re making sales, how many sales they’re making and the dollar amount of sales in each state. They could need to register in the states where they are currently not and start collecting tax.

Businesses should also determine how they’ll comply with the law — by upgrading their software system, or more manual methods — and how they’ll remit tax. Will they prepare the returns themselves, or hire a firm or service provider to help with compliance?

Service providers can do more extensive reviews to see where a business needs to file returns, if at all. Businesses might not track activities close enough, which might expose them to liabilities. If that’s the case, there are ways to resolve the outstanding liabilities they have, but didn’t know about until a review was performed.

Insights Accounting is brought to you by Clarus Partners

The art and science of determining a business’s worth

For many business owners, approximately 40 to 60 percent of their net worth is their company. Given the impact a business transition will have on their future, the business owner needs to be aware of the business’s value to eliminate any unwanted surprises.

“To understand the value of a company, it’s important to have an experienced expert complete the process,” says Rob Zunich, a director at Barnes Wendling CPAs.

Smart Business spoke with Zunich about some of the aspects and processes involved in a business valuation.

What are some occasions when a business valuation is needed?
Business valuations can discover critical information in a number of situations. There are various circumstances that require a business valuation from a qualified expert. Some of these occasions include:

1)  Buy-Sell Agreements. Buy-sell agreements between co-owners stipulate what owners receive when a partner experiences a life-altering event such as death or disability. If co-owners specify an amount in the agreement that doesn’t adequately capture the true market value for the business, it can delay, complicate or potentially derail the transaction.

2)  Gifting or Estate Planning. Having a value for a specific ownership interest allows owners to effectively transfer wealth to other family members while also meeting IRS requirements.

3)  Succession Planning. A reasonably performed valuation can inform owners of what the marketplace value might be for their business. Occasionally, business owners experience a ‘value gap’ where their own assessment of what their business is worth and the market value are vastly different. A valuation performed well in advance of an exit can manage expectations or provide a roadmap for where action is needed to increase a business’s marketability to buyers.

How is the value of a business determined?
Performing a valuation is a mixture of art and science. There are certain standards or accepted methodologies, but the process also incorporates an amount of professional opinion and judgment. Every engagement provides its own unique set of circumstances.

Also, the type of value being determined is important to understand, and will dictate how certain underlying assumptions and estimates are factored. Appraisers will typically provide a detailed list of information they will want in analyzing the various financial, operating, quantitative and qualitative factors that will be used in their procedures.

Based upon the information provided, the appraiser will then determine which approach(es) are appropriate to consider. These approaches include:

1)  One method considers the underlying net value of a company’s assets deducting its liabilities (those recorded on and off the books). This approach may be utilized for companies that own underlying assets, such as investments or real estate, or for operating companies where the value of selling off the assets and paying off all liabilities provides a greater value than could be generated from the earnings.

2)  Another approach focuses on the earnings or cash flow as the potential benefit to a buyer, and also considers the risks associated with realizing those benefits. Professional judgment by the expert often comes into play in assessing an appropriate risk factor for those earnings.

3)  Lastly, an expert could look to a market approach, where data is assessed from public or private companies similar to the business being analyzed to derive pricing estimates based upon relevant factors.

What should be considered when looking for a valuation expert?
Cost shouldn’t be the only factor in choosing whom to hire. Rather, an owner should inquire about appraisers’ experience in performing valuations; their training, including continuing education; their background and knowledge of the respective industry; and their reputation within the professional community.

An owner should also consider whether such experts have valuation credentials or designations. These would be indicative of meeting certain minimum experience, knowledge and training requirements, and holding that expert to certain required professional standards.

Insights Accounting is brought to you by Barnes Wendling CPAs

Growth through acquisitions: What strategic buyers need to know

All companies try to grow organically. But depending on your industry’s maturity, it’s not always easy to grow from within. One way to supplement this is to acquire another company to gain market share, says John Troyer, CPA, Audit and Accounting Services Department, Partner-in-Charge at Ciuni & Panichi.

“For companies that want to grow their topline, and hopefully their bottom line, acquisition can be the easiest path,” he says.

However, strategic buyers, especially those who are new to these transactions, need to make the right moves to ensure a ROI. This is critical in today’s seller’s market.

Smart Business spoke with Troyer about what business owners need to remember when doing an acquisition.

Is now a good time to buy a business?

There’s a lot of capital in the market. The economy is strong. So, companies have good cash flow to finance an acquisition and banks are interested in lending to their customers. But in the near future, it should remain a seller’s market — even with baby boomers without strong succession plans looking to sell. Strategic buyers are competing against financial buyers, like family offices or private equity firms, which drives prices up.

How do you find a company to buy?

Look for a business that complements your industry, product lines, customers or geography. If you buy a competitor, there’s a double benefit as you reduce competition in your existing sales space. Another target could be a supplier. Vertical integration reduces uncertainty in your supply chain.

Consulting a team of advisers certainly helps. Business brokers specialize in sales transactions and can identify available companies. Meet with your CPA, attorney and banker, and express your goals and objectives. Professionals usually have large networks and often are the first to hear a company is on the market. They also can advise you how to finance and structure a transaction.

What happens when you identify a target?

It helps to have an existing relationship before you start the conversation with a target company. The seller likely will require a nondisclosure agreement. And you, as the potential buyer, will want to negotiate a letter of intent — with the help of your advisers — to make sure the buyer is serious and realistic with the price. Sometimes emotionally attached sellers have an unrealistic view of their company’s worth.

Perform your due diligence to understand the strengths and weaknesses of a potential acquisition. An experienced adviser can identify risk and opportunities in the information provided by the seller.

How do you determine a fair sale price?

There isn’t one way to value a company. You can project the future cash flows, or look at historical cash flows, similar private transactions or the book value. Whatever method, the sale price should be set using sound financial data. There’s risk with all transactions, so make sure your projected ROI justifies what you pay.

Again, surround yourself with advisers who have been through transactions. Try to take the emotion out of it. You don’t want to be on the wrong side of a transaction — where the other side is experienced at making a deal and on your side, there’s inexperience.

What else do strategic buyers need to know?

With the rise in valuations, it can be hard for companies to find what they’re looking for at a good value.

While a private equity firm could be looking at a shorter ownership window, it’s harder to flip a company at a profit in a seller’s market. Sellers typically are looking for more cash up front, but a strategic buyer also may appeal to their emotions. A lot of sellers want a buyer who will be loyal to their employees and around for the long haul. Some sellers want to see their legacy carry on, and not be swallowed up by a larger company where the name goes away.

Buying a company takes significant capital. You have to be confident in your ability to run the new company effectively. Have a plan for the operations. Go into it with your eyes wide open, so that the acquired company is a positive contributor to your cash flow. If you’re losing money, it’s not only problematic, it can also cause you to take your eye off the ball of your existing operations.

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