How to run a construction company so it yields more bottom line profit

If you are manufacturing widgets, your production environment is pretty much a controlled one. Temperatures in the plant are consistent year-round, as is the speed of your production line. Other factors are well within accepted levels also.

But think of the construction company. There are unforeseen conditions, the size and scope can be staggering and the quality of workers can vary.

“A construction company does not have that luxury of consistency. Therefore, every job is unique and presents its own challenges,” says Kent Beachy, CPA, CIT, CCIFP, principal and director of construction services at Rea & Associates.

To build a more profitable construction company, taking into account these challenges takes a four-part approach.

“You first estimate, then you do the work, then you account for it and then you analyze it,” Beachy says. “You bring all those pieces together, then you tweak it, and see that you can make money in the business, and then you go for it.”

Smart Business spoke with Beachy to learn the keys of building a more profitable construction business.

What’s a good rule of thumb to follow as your first step toward profitability?

You have to be able to estimate for profit. Construction companies are generally bidding against the competition. You have to know your company’s backlog, what work flow you have in place, how busy the company is at present and how busy it will be when construction actually begins.

What other considerations are there?

Is the job within a niche of yours where your labor is skilled and has done work before and can do it efficiently and effectively? Or is it something new that you’re going to have to get up to speed on? That is a risk factor you have to be concerned about.

If you are a general contractor, you have to consider the subcontractor, what is his or her schedule and if you can use him or her.

If you are a subcontractor, you have to consider if you have the labor in place and will be able to get the job done effectively and efficiently.

You also have to know your overhead — the fixed prices, utilities, rent, the telephone — to be able to estimate for profit.

What about benchmarks and key performance indicators?

Another process within a more profitable construction company is being able to measure the financial aspect of your company. That includes breaking it down by job using a construction accounting software that allows you to job-cost.

That way, you’ll know whether or not you’ll have potential change orders, work that is added to or deleted from the original scope of the job. You have to be able to manage a change order and still be profitable.

After you tally up the figures for these jobs, then you can do your analysis. For instance, if a company wants to measure profitability on a job, you would measure gross profit margin. If you want to measure profitability within the company, you would measure return on assets or return on equity. Liquidity ratios, such as the current ratio, is an important measurement and one the surety is interested in as it measures to what extent your current assets are available to satisfy your current liabilities. An efficiency ratio one may want to consider is backlog to working capital. While backlog represents jobs waiting to start, the relationship between committed work and working capital may determine if you need more working capital to be able to finish the work.

How can ratios help you analyze your company’s performance?

You could do comparisons to industry — in fact, that is how you benchmark. You can get ratios for the industry through the Construction Financial Management Association, which conducts surveys. You can benchmark against the industry and determine which ratios are key to the company’s performance and measure those.

You can put everything in a nice package and show the company executives where they’re at. But you want to be able to determine what ratios are important to the company, to its profitability. Just a few ratios will make sense to the owner, the controller or other executive so they can measure on a regular basis to spot signs that will let them know if something is wrong.

Insights Accounting is brought to you by Rea & Associates

Protecting your company from state tax exposure in your next acquisition

When you acquire another company, there is a hidden exposure that is catching many new owners by surprise — state sales taxes.

Often, the entity’s prior owners did not file sales taxes in a number of states they were doing business in. Then, one of those states conducts an audit and notifies the company of the tax liability, interest and penalties.

As the new owner, this is something to pay attention to because states have the ability to come after the company and current CEO, CFO and/or board of directors, regardless of when the tax was incurred.

“Most, if not all, states have these types of laws on the books. In addition, it doesn’t matter if the deal is a stock or asset acquisition, or what your corporate structure is,” says Mike Goral, partner-in-charge of State and Local Tax Services at Weaver.

“As the buyer of a company, you may not know that this risk exists. The issue can even make the transaction completely different,” Goral says. “States can put levies on bank accounts and can even go so far as to use criminal sanctions in order to get the company’s attention.”

Smart Business spoke with Goral about this contingent liability and how you can mitigate the state tax exposure.

Why is this state tax liability even more of  a risk right now?

States have become much more aggressive with this issue. Their budgets are down, and they’re looking to generate revenue. When states become aware that a business should have been filing sales tax, they will pursue it to get those back taxes.

Part of the problem is that there is no statute of limitations. So, if you haven’t filed a tax return, the state can go back to whenever the company first started doing business in the state, whether that’s five, 10 or 20 years ago. This can lead to a small initial tax liability growing exponentially over the years as interest and penalties are imposed on top of that. For example, in one case, Hawaii went after a company for a $5,000 tax from 1978. In the end, the company had to pay significantly more after interest and penalties incurred over the years were applied.

Private equity and venture capital firms that are holding on to their investments may be completely unaware of this exposure, which could mean a good deal turns bad or becomes less attractive.

Wouldn’t it make sense to get these back taxes from the seller?

The state has the ability to go after either the seller or the buyer, and it may decide to pursue the entity within the easiest reach and/or with the deepest pockets. As the buyer, you can pay the tax and then sue the previous owner to recoup the cost using the indemnification in your sale documents. However, this can be complicated if the seller has moved to another country, for example.

How do you recommend companies proactively deal with this risk?

Before the transaction takes place, consider a nexus review for sales tax purposes to see whether the prior owner has sales tax exposures in any states. If there’s exposure in just one state, it could be immaterial; but if the company owes a small amount in 10 different states, the tax liability can add up quickly.

If the nexus review spots a problem, a potential buyer can:

  • Set aside extra funds in escrow.
  • Work out a voluntary disclosure agreement, where a neutral third-party contacts that state on an anonymous basis to settle the tax.
  • Reduce the purchase price.

The right strategy depends on the situation and the deal’s structure. However, at any time, a buyer or seller can start the procedure for a voluntary disclosure agreement, which may take two or three months to negotiate. States usually ask for three year’s worth of taxes and interest before waiving all penalties and prior back taxes and interest.

Taking the extra steps to better understand your state tax exposures will take more time and money up front, but it can save both the buyer and seller a significant amount of money in the end.

Insights Accounting is brought to you by Weaver

How to manage risk and counter crises with a corporate response plan

The goal of any incident response is to minimize the impact of a negative event on an organization’s objectives. This involves responding to an incident as quickly and efficiently as possible, making good decisions to limit further damage and repair any damage that has been done. In order to accomplish this, an organization should have a corporate response plan (CRP) in place that is ready to go at a moment’s notice.

A CRP typically includes an oversight committee that will design the CRP and oversee the work of the corporate response teams.

Smart Business spoke with James Martin, managing director at Cendrowski Corporate Advisors LLC, about the finer points of a CRP.

What sort of events should be addressed with a CRP? 

A CRP is a natural extension of an organization’s risk management process and can be designed to address risks that are particular to an organization and its industry. Such a plan could help manage risks that have a high likelihood of occurrence and a high impact if they were to occur. An organization might have several CRPs, each designed to address specific events, for instance cybercrime, fraud, business interruption and other public relations disasters.

Why does an organization need a CRP?  

Risk management attempts to identify and mitigate risks, however, it is impossible to completely prevent risk occurrence or even to identify all risks facing an organization. This is why an organization needs to be ready with a plan. The future really is unknowable; the goal of the CRP is to make sure the organization has a mindset of preparedness and the basic tools to manage a risk occurrence when it happens.

What are the basics for setting up a CRP? 

Setting up a CRP is an extension of the risk management process. It involves deep planning around what tools will be needed for specific threat types and proactively ensuring they will be available.

When a risk actually occurs there will be no time for planning and coordination, so it needs to be done upfront. Consider who should be involved, both from a company perspective and any outside experts who would be required. Identify the information that’s essential to evaluate the extent of the threat and analyze an appropriate course of information. Also, consider procedures to ensure that data and information are adequately preserved and available for the CRP.

Who should be involved?  

A corporate response committee should tailor the CRP for the company’s situation and determine who should be involved with the operation of a response team. The team is responsible for operating the CRP when an event occurs. Of course, for IT security events the committee should include members of the technology team. The members of the committee should be senior management so they can authorize the CRP and provide team members with the authority to examine transactions and events on behalf of the committee.

What are the keys to success?  

Planning needs to be done to progress from threat identification to a desired outcome — the organization needs to determine the acceptable end resolution. This will also vary by threat type, but should consider the overall goals of:

  • Minimizing business impact.
  • Resuming normal operations.
  • Repairing any damage done. 

Consideration should always be given to the need for confidentiality. For certain threats, such as a report that fraud has occurred, the CRP should involve confidentiality during the process to ensure that the investigation can proceed appropriately and protect the rights of the parties involved.
As with any other risk management activity, the CRP should also include an evaluation process to gauge the effectiveness of the response and identify areas to improve. Also, the risk occurrence and mitigation information should be used to check if prior risk evaluations for risk impact and likelihood ratings need to be updated.

Insights Accounting is brought to you by Cendrowski Corporate Advisors LLC

Why transferring your IRA into your 401(k) plan might be a smart move

The reverse rollover is a financial strategy that involves transferring your IRA assets into your company’s 401(k) plan.

If this is the first time you’ve heard of this approach, you’re not alone.

“The average retirement-minded taxpayer thinks that there is something inherently wrong with combining different types of retirement accounts,” says Kory Klein, CPA, a Principal in the Business Management division at RBZ. “While that is true for many retirement accounts, it is not true for all.”

Smart Business spoke with Klein about what you need to know when deciding if a reverse rollover is right for you.

What are the benefits of doing a reverse rollover?

Company 401(k) plans offer benefits that individual IRAs do not.

You can take distributions from a 401(k) plan without a 10 percent penalty once you are 55 years old and have separated from your employer.

With certain exceptions, you cannot take money out of an IRA without penalty until age 59 ½.

The funds in your 401(k) plan also have greater protection against legal judgments. If it was set up under the Employee Retirement Income Security Act (ERISA), then it is usually protected from creditors.

Most people wrongly assume that their IRAs are protected against legal judgments. If your retirement account is not qualified or covered by ERISA, then a creditor could potentially seize it.

You may find that your company’s 401(k) plan has better investment choices at a lower cost than what you could find on your own.

How do I know if a reverse rollover is right for me?

You may get better investments cheaper. If you work for a large company, there is a good chance that it has put some effort into making sure you have state-of-the-art investment choices. You probably have separately managed accounts within your 401(k). There are portfolios of investments created for your plan that cost less than mutual funds.

You may also want to consider the Back Door Roth strategy.

What is the Back Door Roth strategy?

You can’t make Roth contributions if your income exceeds certain limits.

The Back Door Roth strategy involves making a contribution every year to a traditional IRA and then converting that to a Roth IRA, with the goal of paying little or no tax on the converted amount that has not yet been taxed. The maximum contribution for any type of IRA is $5,500 plus an extra $1,000 “catch-up” contribution if you’re at least age 50.

Usually, when a retirement account has both pre-tax and after-tax money, withdrawals are partially taxable and a calculation needs to be made to determine the taxable portion. The reverse rollover enables the pre-tax and after-tax dollars to be split.

The 401(k) can only accept pre-tax dollars, so that’s an easy way to split it. All the money that’s left in the IRA is after-tax dollars. Therefore, you can move the percentage of money attributed to the deductible contributions plus earnings into your 401(k).

You can then convert the remaining, nondeductible contributions to a Roth IRA. Because the tax has already been paid on these contributions, there is no tax on the Roth conversion.

What do investors need to know before moving forward with this strategy?

If you have older IRAs, you have to pro-rate the amount you convert among all of your IRA money and not just pull from your latest contribution. That could result in a sizable tax bill, as the older IRA money has probably accumulated untaxed earnings that will have to be taxed as they are moved to the Roth.

Here is where the reverse rollover helps: You can move all of your old IRA money into your 401(k). From then on, make the contribution to the traditional IRA and then convert it to the Roth IRA. This way, there will not be any old tax-deferred IRA money to which you will have to allocate a portion of your Roth conversion.

A high-earning couple over 50 could put $13,000 a year into Roth accounts while paying little, if any, extra tax.

Insights Accounting is brought to you by RBZ

How to understand the elements that could make or break your next deal

Tax implications are an important factor to consider in the process of completing a business merger or acquisition.

But problems can arise when you alter the path of a deal simply to avoid a particular change in the tax laws or take advantage of a law that will soon be phased out.

“It’s just one of many things to take into consideration,” says Corinne Baughman, a partner with Moss Adams LLP.

“We don’t want the tax tail to wag the dog. I’ve seen plenty of deals where the client just couldn’t get it done in time. They decided they weren’t going to race just for that. It’s more important to make sure the deal is done correctly.”

Smart Business spoke with Baughman about how to make sure the deal you’re negotiating is right for your company.

What one step can help you make a more informed decision about a potential business transaction?

It’s always helpful if you have people on your negotiating team with experience in your industry, because they’ll know the nuances that come into play, especially as they relate to the types of assets and liabilities you’re negotiating over.

It might not be the person you use on a day-to-day basis, but rather somebody with a specific skill set who would be helpful in this situation.

How do you manage the people involved in this process?

If it’s a group of people who do this kind of work all the time, they know how to get through it. The individuals know that they can’t be seen as the one holding things up, so they keep everything moving forward. They have a working list of who has expertise in certain areas, and it’s all very organized.

One factor is the size of the deal. If you’re doing a $10 million deal, you shouldn’t have more than a handful of people involved. If it’s a $100 million deal and it’s in a highly regulated industry, you’re going to have to get more people involved.

What are some things to consider when assessing the merits of a potential deal?

In every deal there’s usually one side in the driver’s seat. So that side is going to drive the initial conversations about how the deal is going to be structured. Is it a purchase of assets? Is it a purchase of stock? Is it a purchase of limited liability company interests? You get into this process, and you start moving the boxes around.

Look at the proposed structure from a legal perspective and recognize the tax implications of the steps you need to go through prior to any merger or acquisition. There’s never just one step.

You also need to be a pessimist. Don’t expect that whatever positive thing you think is going to happen down the road will happen. If it’s not a good enough deal today— based on the money you get in cold cash — then it’s not a good enough deal period.

How important is it to look beyond the day the deal closes?

It is easy to lose focus because you’re thinking, ‘Hey, the deal is closing on Monday.’

You have the structure down, everyone’s happy and you really haven’t taken the time to model out what happens a year from now if you’re profitable.

What happens if you’re not profitable? What if you don’t hit your targets? What else could impact any future earn-out you’re supposed to get?

You need to not only look at how to get through the transaction, but also at what happens six months from now, a year from now, three years from now, etc.
What are all the things that could happen? Does everybody fully understand what the implications could be if one of those things were to happen?

Insights Accounting is brought to you by Moss Adams LLP

Tips for an efficient, successful month-end close

Closing your books at the end of each month might not be the most exciting part of running a business, but efficient and accurate monthly closings are important for any organization. Month-end closings are not only essential to effective fiscal governance, they also provide management with financial information that drives strategic decisions. The sooner management gets good information, the more quickly they can respond — and organizational agility can be an enormous competitive advantage.

Smart Business spoke with Jennifer Henson, a senior business services associate at Sensiba San Filippo LLP, about how businesses are transforming month-end closings from a cumbersome and stressful process into a value driver for their management.

Why is a streamlined month-end process important?

Month-end can be a very stressful time for finance departments. Management is often eager to get their hands on financial information that will inform their decisions. Developing an efficient, ‘streamlined,’ process for month-end will create a more relaxed environment, free up man hours and ensure that management receives accurate and timely information. When month-end is completed quickly, you can adapt sooner, capitalize on more opportunities and make better strategic decisions.

What pitfalls can slow down the month-end process?

Even a well-designed process can become obsolete as needs change or become cumbersome over time. When data is not recorded correctly throughout the month, it creates a tremendous burden on the month-end process. Finance professionals often find themselves looking for missing expenses, searching for expenses that have been entered multiple times or correcting items that were coded or categorized incorrectly.

Process and procedural problems aren’t the only things that can slow down month end. Many companies spin their wheels tracking information in greater detail than is ever needed. A swollen chart of accounts may require detailed tracking that provides no organizational value.

How can an organization simplify and improve the month-end process?

Before you can fix a problem, you first have to recognize it. Look out for signs of stress within your month-end process. These symptoms might include monthly closings dragging longer and longer into the next month, finance professionals putting in significant overtime at the beginning of each month or general tension related to the process.

Once you decide that your month-end closing process isn’t working, you need to diagnose the problem and take corrective action. Do you have a cumbersome process that is creating unnecessary work? Consider simplifying your chart of accounts.

Month-end problems can also be caused by a failure to define and follow effective recording procedures throughout the month. Set strong deadlines for critical tasks and monitor adherence to your procedures. Many of the symptoms that you see during month-end are actually a manifestation of ongoing problems.

Once your ongoing accounting processes and procedures are fine-tuned, there may be opportunity to improve your closing process as well. Analyze your month-end routine. Follow a checklist, but be able to think outside of it. Ask a lot of questions. ‘Why are we doing this?’ ‘Should we be doing this?’ ‘Are there steps in our process that don’t accomplish anything?’

What else should business owners know about month-end?

Financial accounting, which includes the month-end process, is an important function within any business. It can either positively or negatively affect overall business performance. Business owners shouldn’t hesitate to ask for outside help when they need it. Experienced accountants can help setup a system that works for your specific needs. Professional expertise and experience can be very valuable. It can save a lot of time, stress and angst over the long term.

Insights Accounting is brought to you by Sensiba San Filippo LLP

How outside expertise can help owners focus on their core business

Outsourcing some or all bookkeeping and accounting functions can make a lot of sense for small businesses that can’t afford an in-house accountant.

“They may not have the budget for a full-time or even part-time accountant. An outsourced controllership can fill in and provide affordable ongoing reporting so they have accurate numbers on a monthly basis rather than waiting for an annual accounting cleanup,” says Clayton W. Rose III, CPA, a principal at Rea & Associates.

Smart Business spoke with Rose about various options available to meet the accounting needs of small businesses.

Can businesses use software such as QuickBooks instead of using a professional accountant?

QuickBooks is easy to use, but you need sufficient supervision by someone who is proficient with accounting skills. Otherwise, you’re not analyzing what is going on behind the numbers or utilizing some of the capabilities of the software, such as the reconciliation process, accounts receivable tracking and accounts payable, etc. You could end up with duplicated entries and overstated or understated balances as a result. When problems occur, there could be a lot of fees invested in cleaning up the accounting.

What forms can outsourced accounting take?

It can be a wide range, from full service to partial service or oversight.

If your business operates by the calendar year, you need to clean up your accounting between Jan. 1 and April 15. If you stay on top of your accounting throughout the year, though, this will be a much smoother process. Perhaps bring someone in at the end of six months, and then again in September and December so you can track performance and analyze your tax situation.

Tax planning is always an important part of the process, too. An accountant can help ensure commercial activities and sales taxes are filed on time and the numbers are accurate so you’re not overpaying.

If you’re required to provide periodic financial statements to banks, you need to ensure that your numbers are accurate. If you have a loan based on accounts receivable, banks often want a quarterly report so they know how much they can lend and what balance you need to pay if you’re over the limit.

Some clients just want another set of eyes for their bookkeeper, perhaps to prepare the monthly bank reconciliation. They don’t have enough people on staff to have adequate internal controls, so outside help is needed to provide proper checks and balances. Internal controls are often underemphasized because owners never think they hired someone who would steal. But proper controls will provide a much better chance of catching something if it occurs.

How does a business owner decide what level of outsourced accounting is right?

The primary concern is budget. Do you have the budget to have someone on staff? You also haves to consider if you haves the patience to handle the work. It depends on your tolerance level combined with your desire (or lack thereof) to do accounting. Most small business owners are entrepreneurial and sales-oriented. Someone with a selling attitude typically does not have an accounting attitude at the same time. They want the information but aren’t interested in the details because they’re more focused on the next deal.

The level of service can be adjusted to the needs of the business. One client has been doing some data entry, and having us reconcile balances and actually write checks on their behalf. But they have grown and we’ve had discussions about revising the arrangement. They may be ready to go with an on-site accountant.

One concern companies have is that outside accountants can be a disruption, but that can be minimized through Web-hosted versions of accounting software. Accountants don’t have to visit the office; they can access the software and help with modifications as you go along so that you don’t have to wait to get journal entries back in order to post them.

Outsourcing can be a nonintrusive, cost-effective way for small businesses to address accounting needs until they reach the point where they can afford someone on staff.

Insights Accounting is brought to you by Rea & Associates

How an experienced investigator performs background due diligence

When trying to learn about an individual, many companies turn to online background checks. This could be a mistake, however, as much of the available information may not be fully verified, which is why many businesses turn to a licensed investigator to help provide a more complete and accurate picture.

Smart Business spoke with Theresa Mack, CPA, CFF, CAMS, CFCI, PI, a senior manager at Cendrowski Corporate Advisors LLC, about working with a licensed investigator to help your business uncover the information you need.

 

Why hire a licensed investigator? 

Most online or database-driven background checks are actually ‘record checks.’ In other words, data from records are compiled and the quality of the source information is not thoroughly verified.

This cursory check may be sufficient in some cases. However, depending on the information found, the nature of the background check, the check’s intended use and the access to confidential/proprietary information that a potential employee may have, a complete background due diligence investigation by a licensed investigator may be warranted.

An investigator uses multiple resources to verify data accuracy and corroborate information. Thus, background due diligence investigations help reduce the risk of client reliance on false information.

 

How do investigators perform background due diligence activities? 

An investigator generally works on a six-step methodology: prepare, inquire, analyze, query, document and report. This methodology is highly applicable to background investigations. An accurate and comprehensive investigation is based upon existing, determined and verified information, leaving no stone unturned.

Investigators will tailor their activities to suit the needs of their clients, which typically include attorneys, businesses and individuals. Client needs will define both the records checked by the investigator and the type of documents that can be released to the investigator and the client.

 

Where does an investigator begin? 

An investigator often begins by examining open-source information, which refers to sources that are overt and publicly available. These are available through online data warehouse applications, which house data from disparate sources.

Open-source information includes public documents that are created throughout a person’s lifetime, allowing the investigator to follow a paper trail leading to a complete history of the individual being searched. These may include court filings, property tax documents, vehicle registrations and social media sources. Open-source intelligence is a form of intelligence collection management that involves finding, selecting and acquiring publicly available information and analyzing it to produce actionable intelligence.

 

How does an investigator evaluate sources? 

Any record is only as good as the chain of events involved in its creation. Online record checks simply provide information on an individual. Investigators go further by evaluating the veracity of the source data.

Record maintenance, storage and dissemination procedures can often impact the accuracy of the information. Typos, misprints and mistakes introduced by human error can also affect the accuracy of records. These latter items are often seen on personal credit reports, criminal convictions and even civil litigation histories. While these are official records, they can contain errors nonetheless.

Processes for updating records can also compromise the accuracy of information, as records are only as accurate as their frequency of updates. Some records are never updated and may provide stale data if the user is unaware of this underlying issue.

Finally, the method that data warehouses employ for acquiring information critically impacts information integrity. For instance, the provider may have purchased information from a secondary source. In such an instance, it is essential that the provider have accurate retrieval processes and is knowledgeable about handling special data items.

An investigator evaluates each of these issues over the course of conducting background due diligence activities.

Why conducting regular royalty audits with your licensee is good business

Royalty auditing is a best practice that can strengthen the relationship between licensors and licensees. The key is building a customized audit program that ensures that licensors are getting what they signed up for in a contract agreement.

“The tendency is to audit the poor performing or problem licensees, but even well performing licensees with good systems for managing financial records should be audited if those licensees are very large or geographically dispersed, or have complex language in their contracts between the two parties,” says Dean Bower, CPA, Manager of Royalty & Contract Compliance Services for RBZ.

“There can be errors in the system that can go undetected and will not be found any other way except through a royalty audit. Sometimes it gets down to differing interpretations of the license agreement, which result in significant underpayments.”

Smart Business spoke with Bower about what licensors stand to gain through an effective royalty audit program and how it can lead to a stronger partnership with licensees.

 

What is the best time to conduct an audit?

Ideally, licensors should adopt a rotating cycle of audits as part of an overall program. However, circumstances might accelerate the need to audit a licensee, such as a change in ownership or major changes in personnel. Suddenly records or the knowledge of how your royalty statements were prepared become unavailable to audit. If a licensee implements new accounting software, it can take up to a year to get all the bugs out of the system, which can also affect your royalties.

Licensees with contracts approaching expiration should be audited so you know what issues to address in a contract renewal. Finally, many license agreements have a time limit on contesting royalty statements. After that, statements become final and can no longer be audited. Licensors should mark their calendars for these important dates.

 

What is the best way to approach a licensee when you are considering an audit?

Keep in mind that a licensing agreement is a partnership built upon mutual needs. The licensee needs a brand or an idea, and the licensor needs commercialization. Licensors rely on receiving regular streams of royalties. It is a standard practice for licensors to audit royalties in the course of managing their businesses. Large consumer product licensors have royalty compliance programs and actors, directors and creative talent, and recording artists all conduct royalty audits.

You are just making sure you receive the money owed under the provisions of your contract with the licensee.

 

What are some non-monetary reasons to do a royalty audit?

Advertising and marketing should be approved by the licensor to ensure that it is consistent with the brand’s identity and is reaching an appropriate audience. Distribution channels are another area. Territories and retail stores should be defined in a license agreement or you might find your high-end brand selling at a discount retailer, resulting in a lower sales price and royalties. But the larger issue is the image of the brand can be compromised.

 

What is an audit cost recovery provision?

This is contract language that specifically provides for a reimbursement to the licensor for audit fees if an inspection of the licensee’s records reveals underpayments over a certain defined amount or percentage of reported royalties. The licensee would pay the licensor for the cost of the audit. Audit cost recovery should be in all license agreements. Royalty audits usually pay for themselves and over time become self-funding.

 

How is the licensor/licensee relationship strengthened through the audit process?

A royalty audit can bring to light a wide variety of issues from differing contract interpretations, to faulty systems and basic misunderstandings. The inspection process allows for a thoughtful discussion of these issues, allowing both parties to have a better sense of their relationship so they can proceed with confidence.

The COSO effect: How the new control framework adds value, not just work for work’s sake

Every business, private and public, has a control structure. Internal controls — often called COSO after the Committee of Sponsoring Organizations that has set the standard for internal controls since 1992 — are the functional steps that process accounting transactions generated by a business.

Every company wants to profit by providing a product or service, and therefore, transactions must be initiated and recorded. The internal controls are the baseline framework to execute that.

“The current business environment is highly automated and global with more of a remote workforce and increased transparency. So, those kinds of activities needed to be reflected in the COSO framework,” says Alyssa G. Martin, a partner in Risk Advisory Services at Weaver. “This framework that we are all ‘supposed to follow’ was essentially stale. It wasn’t a reflection of the real business environment today.”

COSO recognized that migration by releasing an updated framework last year.

Smart Business spoke with Martin about these COSO changes and what they mean for those who run companies.

When do these changes go into effect?

The updated framework was approved in May 2013. Organizations in regulated industries, such as banking, insurance or health care, and those accountable to the U.S. Securities and Exchange Commission need to evaluate and update their control structure against the new framework by December 2014.

Others like large private organizations in unregulated industries aren’t required to use the new framework. However, these controls are best practices that are worth emulating.

How has the framework been updated?

The COSO framework still has 17 components, but those components are revised, renamed and renumbered. A couple of the biggest differences relate to data security and fraud prevention. The old framework did not explicitly recognize the reliance on technology in the ordinary course of business, as well as the need to specifically prevent and deter fraud. Further, the revised framework is more focused on overall coordinated governance, such as no longer viewing HR policies and procedures as separate from company-wide policies and procedures, and managing risk to meet business objectives.

How can an organization get started on following the new framework?

Corporate internal control structures sit along a spectrum that ranges from unintentional actions that focus on just trying to record transactions to highly intentional, effectively controlled and mature.

Every business should evaluate its structure against the new framework. As an outcome of the evaluation, if you fall toward the mature, effectively controlled end of the spectrum, the business is likely already following these changes. Ad-hoc organizations that are not strongly controlled, stale and/or highly manual are looking at more material changes.

Your chief financial officer, chief accounting officer or controller — whoever is responsible for the accurate reporting of financial transactions — needs to compare your internal controls to the new framework in a high-level gap assessment. Even if your processes aren’t well documented, this person knows best what practice is in place, and if it’s working or needs improvement.

Then, consider getting consultative help to implement the new framework. External assistance provides a competency and skillset to apply this framework efficiently. It is also a labor source to complete a project of this scale while people who work in the company are doing their normal jobs.

What’s the takeaway for business leaders?

This new framework is a good excuse to take a fresh look and determine if the way business is transacted could be more effective, efficient or automated in order to benefit the company. Every business can benefit from having internal controls that are intentional and preventative focused.

It may seem like work for work’s sake, but if you have to go through this exercise, then use this opportunity to look at efficiency and effectiveness. Are your processes scalable if the company experiences growth? Are you using automation that can be preventative and have low labor costs? Is it standardized, so it can be transferred to a new location?

The paradigm in which you approach this has a direct relation to the value and output at the end, which is why consultative assistance is so beneficial. Those experts can help you get more value versus simply going through an exercise to check the right boxes.

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