small business

Exit Strategy Techniques Using an Employee Stock Ownership Plan (ESOP)

by Tom Gray | on May 30, 2012 |  Comments

Small business owners can use an ESOP to sell their business for its market value. They can do so gradually over time through regular annual tax-deductible company contributions to the ESOP, or in a single set of transactions using a “leveraged ESOP.”

As described in a prior article (see Employee Stock Ownership Plans (ESOPs) and Small Business | Thomas H. Gray), the ESOP then uses these funds to purchase shares from the company or from some or all of its stockholders.

The previous article defined the advantages and disadvantages of an Employee Stock Ownership Plan (ESOP) for employees, the company, and the owner of a small business.  In this article, we will consider how an owner can use a leveraged ESOP transaction to sell some or all of the owner’s shares at once, as an exit strategy for the owner.

Leveraged ESOP Definition

A simple or basic ESOP uses regular annual company contributions to buy the company’s stock. However, an ESOP can also borrow money to finance the purchase of shares of the company’s stock.  When it does so, it is referred to as a “leveraged ESOP.”

While a “direct” loan to the ESOP might be appropriate in certain cases, banks more commonly prefer to loan funds to the company rather than directly to its ESOP.  The company then re-lends the funds to the ESOP. This is sometimes called a “Back to Back Loan” and the company’s relending of the bank loan proceeds to the ESOP is called the “ESOP Loan.”  Often, the ESOP Loan will have different repayment terms than the terms of the bank loan, such as lower interest rates and longer amortization.

Although beyond the scope of this article, it is worth noting that since the stock purchased by the ESOP is held in a “suspense account” and allocated to participants’ individual ESOP accounts only as the ESOP Loan is repaid, the company has the flexibility to structure the repayment period of the ESOP Loan so as to provide equity ownership to employees that may be hired well into the future and not just to its current employees.

Use of Funds

The ESOP must use these borrowed funds solely to purchase “employer securities.” In most privately-held companies with only one class of shares outstanding, these will be the shares of the company’s common stock. However, when there is more than one class of common stock or series of preferred stock, the stock that can be purchased by the ESOP must have the “highest and best” dividend and voting rights of all classes of the company’s stock.

ESOP Loan Repayment

The ESOP Loan is repaid to the company using the annual tax-deductible contributions made from the company to the ESOP. These company contributions are then returned to the company in the form of payments on the ESOP Loan. Companies are limited by Federal tax law in the amount of tax-deductible contributions it can make to its qualified employee benefit plans (e.g., 401(k), profit sharing plans, ESOPs, etc.).  The general limitation is 25% of a company’s payroll per year.  However, over and above this general 25% limitation, companies may make a contribution of an additional 25% of payroll per year if this additional contribution is used to fund the repayment of an ESOP Loan.

Owner’s Sale and Tax Benefits

The owner achieves the maximum tax benefit by selling at least 30% of his company stock to an ESOP and re-investing the proceeds of his share sale into stocks and bonds of US companies (called “replacement property”), as noted in the earlier article.

The share price that the ESOP pays to the owner for his shares cannot exceed the fair market value of the shares to be sold to the ESOP. An owner might receive a higher price by selling to an unrelated party (rather than to an ESOP) who, as a result of synergies gained from acquiring the company, might be willing to pay an acquisition premium, perhaps as high as 20-30% above the appraiser’s determination of the fair market value of the shares if sold to an ESOP.

However, in such a non-ESOP sale, the purchase proceeds that the owner received would be subject to contemporaneous payment of Federal and state income taxes. If that deal was structured as a “stock swap” to avoid such taxes, when the owner sold the buyer’s stock to diversify, again Federal and state income taxes would have to be paid.

In contrast, if the owner sold his shares to an ESOP, by complying with certain requirements he or she would be able to defer and possibly avoid entirely paying any Federal or state income taxes on the gain realized from the sale.

The “tax deferral” referred to above is only available to “C” Corporations.  Thus, if the company were an “S” Corporation and wished to remain so, while ESOP solutions are still feasible, the owner’s tax treatment might be less advantageous.

Maximum Tax Benefit: the “Home Run” Scenario

The “home run” transaction is for the owner of a “C” Corporation to sell his or her shares to an ESOP, elect to defer taxes on the gain by reinvesting in qualified replacement property, and then have the company elect to be taxed as an “S” Corporation after the transaction.

Why does this produce the maximum tax benefits? As we discussed in the previous article, an “S” Corporation does not pay Federal (and most state) income taxes.  Instead, the income, losses, gains, etc. are “passed through” to the shareholders of the “S” Corporation and they have to pay ordinary income tax on their share of the company’s taxable income and gains.

Ordinarily, an “S” Corporation would make a cash distribution to its shareholders that would, at a minimum, enable them to pay these taxes. However, the ESOP Trust is a “tax exempt” entity.  Thus, if the ESOP has purchased all the owners’ shares and has itself become the owner of an “S” Corporation, since the ESOP doesn’t have to pay any Federal (or most state) income taxes, the company would not have to make these annual cash distributions to the ESOP Trust.

This cash would then be available for other corporate purposes, such as repaying the company’s bank loans that funded the ESOP Loan.

In this “home run” scenario, owners have sold the company and the ESOP is the new owner. The owners, if continuing to be actively employed, can continue to collect salaries (and bonuses). If they do not elect the “tax deferral” option, they can also participate in the ESOP on the same basis as all other employees.

If they elect the “tax deferral” option, they could choose to use the investment income earned on the “replacement property” purchased with their sale proceeds to supplement (or, if they do not remain actively employed, replace) the income they previously received from the company.

This extra cash retained by the company can be used to pay off debt, purchase appreciating property, make acquisitions and otherwise grow the company, or pay dividends to its owner – the ESOP. All these uses increase the value of the shares in the individual employee ESOP accounts.

Getting Started with an ESOP

The main requirement to use a leveraged ESOP exit strategy is that the company (or the ESOP) has the credit capacity to get the loan to fund the large share purchase.

What steps would a small business owner take to find out if an ESOP exit strategy fits for him and his company? This quote from Using an Employee Stock Ownership Plan (ESOP) for Business Continuity in a Closely Held Company sums up the process:

“Create an initial business plan, factoring in legal costs, the costs to buy the shares, and the company’s cash flow. If that looks encouraging, talk to an accountant about your figures. If things still look promising, have a valuation done. Your valuation specialist will tell you how much your stock is worth and should also give you a more detailed idea about the practicality of selling these shares.

“If things still look good, hire a qualified ESOP attorney to draft your plan [Editor’s Note:  and to help structure the ESOP transaction to fit with your objectives]. As you consider an ESOP, find some other ESOP company executives to talk to, attend an ESOP meeting or two, and finalize your plans with all the key players.”

The next article in this three-part series summarizes the experience of one small business owner who sold his independent insurance agency to the company ESOP.

This article relies heavily on advice from Robert Schatz, Partner, ESOP Plus®: Schatz Brown Glassman Kossow LLP, 1007 Farmington Avenue, Suite 4, West Hartford, CT 06107, 860-231-1054, www.ESOPPlus.com, rschatz@esopplus.com, but Tom Gray is solely responsible for any errors in properly expressing that advice.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com

 

The Easy Way to Use Your Numbers, and Survive

by Tom Gray | on Jan 06, 2012 |  Comments

“But I hate numbers; I like people,” said the small businessman. Then that no-longer-so-friendly banker called to say the loan payments were late, and the owner had to let some of his now-disappointed staff people go, and he had to get stricter with some of those nice but late-paying customers, and the ones who always came back for changes and even returns.

What happened? He ran the business like a social club, where relationships are all that matter. But a business needs cash to run. Without cash, the relationships disappear. When cash flow was weak, the foundation was tottering, but he refused to look down there. “Every time I look down there, I have to study things and make unpleasant decisions, so I don’t look any more. I just let my accountant look.”

If you don’t attend to your numbers, your business will fail. You should be eager to see how you’re doing! And eager to fix any problems, so the business can go on. It’s not hard to assess your business financial health, if you focus on “percent of revenue.”

You don’t need expertise in bookkeeping if your results are presented in a way that enables planning. You want these numbers to stand out: percent of revenue for every line, and the key lines are total variable costs, total fixed costs, and contribution margin. For a good way to present the information, see Owning Your Own Business Means Owning Your Own Books | Thomas H. Gray – Consultant, CEO, Director.

With your data in Excel, you can experiment. Copy it onto a new worksheet, or save it under another name, and then change the data to see how changes in your business would affect the bottom line — profit.

Sample Analysis: Profit Up 20%!

Assume you want a minimum profit of 10% of revenue, which will be something like 7.5% after income tax. If your fixed costs are 30% of revenue, then your contribution or operating margin MUST be 40% of revenue to cover that 30% overhead and leave a 10% profit.

If you can cut overhead from 30% of revenue to 25%, your profit goes up from 10% to 15%. Review your overhead or fixed expenses to see what changes make sense.

  • You’ll see that small changes, such as not buying soda for the office refrigerator, have little or no impact.
  • If you cut marketing (probably no more than 5% of revenue), what will happen to your flow of new customers? Is such a cut worth the risk?
  • Maybe you can reduce nonproductive labor hours by changing work schedules. This is always worth examining. If this number is 5% of revenue including payroll taxes, cutting it to 3% raises profit by 2% of revenue, which is a 20% increase in profit from 10% to 12%! “Thanks for the raise,” says the owner.

Analysis Techniques

Variable costs and revenue are usually the most fruitful areas to consider. The FIRST technique here is to understand the profitability of each product or product type. On a separate worksheet in Excel, consider each product type. Show the revenue for one unit, and the variable costs to produce it. Subtract costs from revenue to see product profit, and then show that as a % of revenue.

If this product profit is more than 40% — your 10% profit target plus 30% for overhead coverage — great! If it is less, you must do something. Your choices are: raise the price, reduce the variable cost, stop selling it, or accept a profit lower than your target.

  • If you stop selling it, and you can replace the revenue by selling more of other products, your profit will increase as a % of revenue.
  • If you can reduce the variable costs for the product, your profit will increase as well.
    •  One technique is to pay less sales commission on less profitable products – change your commission structure to be different per product.
    • Another technique is to change your production process. This is the BEST approach, and there are many techniques. They all start with mapping out the process as it is today, and then imagining what might be changed. See
    • A third technique is to move some subcontracted work in-house to use nonproductive hours, or move some work to other suppliers if you can offload the associated payroll hours. See Process Improvement | Thomas H. Gray
  • Raising the price is the FASTEST way to improve profitability. A small price change may not be a problem for your customers, yet it will have a major effect on profit. For example, a 5% price increase would raise profits from 10% to 15%, a 50% gain! Even if you lost a few customers, the gain may be worth it. See Pricing Tips: Start High; Big Results from Small Changes | Thomas H. Gray – Consultant, CEO, Director.
  • You can use Excel to change the price and revenue per product, and reduce the number of units sold to see how many sales you could afford to lose yet still be better off.

A word of caution: be careful of major investments that you hope will solve the problem. Examples include a major machine purchase, a major new marketing program, or moving to a larger newer location. They deserve their own careful analysis of costs vs. likely benefits. Your entrepreneurial optimism might be your own worst enemy with such major commitments!

Your numbers are begging for your attention! They control the life and death of your business. It’s not hard, if the numbers are presented the right way. When variable costs, fixed costs, and margins are presented in terms of % of revenue, you don’t have to be a bookkeeper or love numbers to see what’s out of line.

Have you tried this?  What did you learn?

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com

Owning Your Own Business Means Owning Your Own Books

by Tom Gray | on Jan 05, 2012 |  Comments

Most small business owners don’t understand bookkeeping, Quickbooks, contribution margin, or cash planning, so they shy away from learning how to use their results to improve the business.

Yet when small businesses fail, it’s because they run out of cash. Why does this happen, and why do owners allow cash shortages to develop in the first place? Too often, it’s because they don’t try to understand their numbers.

They assign someone else to “keep track” of the numbers.  Unfortunately, bookkeepers are not planners. Bookkeepers look backward, not forward. Owners are the only ones whose job includes using past performance to improve future results, but they usually do not know how.

The owner is the expert on what the business does, spending up to 80 hours per week to make sure the business has effective operations, and maybe even spending some time on getting new customers. Small business owners typically do not make it a priority to understand their numbers well enough to predict their future. Short term demands make future planning seem like a low priority. Then they run out of cash!

Fortunately, it is not difficult for small business owners to understand their numbers well enough to plan, even without learning software (e.g., Quickbooks) or bookkeeping. Three techniques are all they need.

  • First, require the bookkeeper to export the monthly Quickbooks Profit and Loss Report to an Excel spreadsheet with one column for each month of the year.
  • Second, have the bookkeeper reformat the data in Excel into an Income Statement with a reasonable number of revenue and expense categories (see below), and for each category heading show the “% of Revenue” in that line.
  • Third, study where the money goes and create ideas to change those percentages.

Let’s look a little deeper at each of these techniques. First, the Internet has dozens of entries telling the bookkeeper how to export data from Quickbooks to Excel.

Making Quickbooks Reports Manageable

In the second task, you are making the Quickbooks data more useful by reducing the number of entries to a manageable number. For revenue, you should have a summary line for each product type. Even in a job shop, you can categorize your jobs into types.

The next main category is variable expenses, or Cost of Goods Sold (COGS). Your lines for variable costs will be labor (and associated payroll tax and possibly benefit costs), materials, subcontractors, shipping, and sales commissions. The labor line will include labor costs devoted to production, with nonproductive labor hours shown elsewhere as overhead costs.

The last major category is fixed or overhead expenses, those that stay the same regardless of production volume. Here is where you will invent headings and summary lines to group costs by type, so the number of lines is manageable. Ten categories should be sufficient. For example,

  • Nonproductive labor/tax/benefits
  • Salary/tax/benefits
  • Facility costs (rent, maintenance, utilities)
  • Computer costs (hardware, software, maintenance)
  • Vehicle costs
  • Office expenses (include phone and bank charges)
  • Professional services (accountant, legal, consultants)
  • Marketing costs (include travel and entertainment)
  • Dues and Licenses (professional licenses, conferences, dues and subscriptions)
  • Miscellaneous – but try to keep this minimal!

This is a lot easier to work with than 30 or 40 accounts, most of which say 0 for the month! If it is easier to work with, there is a better chance you actually will work on it!

Analyzing the Results

The third technique is analyzing the results. This is the owner’s job, and no one else’s. Up to this point you have simply been telling the bookkeeper to present the data in a more useful way

Analysis starts by looking at % of revenue for each line. The key line is “contribution” (to cover overhead and provide profit), also called gross margin. This is revenue minus variable costs, or revenue minus COGS to some accountants.

Hopefully this margin is at least 50% of revenue. Why? This margin is what you have left after building the product, and its job is to pay for overhead and leave a profit. If your margin is 50%, and your overhead is 30% of revenue, then your pre-tax profit is 20% — a good number.

Numbers are the way we keep score. Without them, you can’t know if you are winning the game or losing, until it is too late! Small business owners can avoid a cash shortage without expertise in bookkeeping. The secret is to present their results in a way that enables planning, using percentage of revenue and contribution margin. In the next article, we will discuss how you can use this data to improve your business.

Does this seem do-able so far? Does it seem worth doing?

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com

 

Employing Family

by Tom Gray | on Jan 01, 2012 |  Comments

Small business owners often resort to employing family members because they are available, known, and trusted. But workplace problems are more difficult to solve when they involve family members, requiring special attention to management tools and techniques.

Relationship Issues

The word “family” is positive. It conjures up images of teamwork that are wholesome, loyal, friendly, etc. Many employers talk about their workforce as family. But anyone who is actually in a family – that would be most of us! – has felt family discomfort too. All the relationship issues in real families crop up in workplace families as well: sibling rivalry, feeling unappreciated, expecting forgiveness for repeated trespasses.

When the workplace family has some real family relationships as well, there are some rewards, but the risks resulting from dysfunction can be many times more serious. This risk is multiplied again where there are only a few employees – when the teapot is smaller, the tempest brews more quickly and explosively. And who does the most family hiring? You guessed it – the companies with the fewest employees: small business.

The Best Person for the Job

Why hire family? As Willie Nelson sang, “I’ve got a long list of real good reasons…” Some are trust; the devil you know; loyalty (he needed a job); tax benefits; and the expectation that family will be committed and willing to sacrifice from time to time when the business needs it.

Unfortunately, one does not often hear that the family member was the most competent candidate: “I needed a marketer, and my son Bill is the best marketing guy I’ve ever met.” Small businesses live on the edge. They are the businesses who can least afford mediocre employees. Small businesses need committed multi-talented people.

What Can Go Wrong?

The reasons to avoid hiring family are mostly about what can go wrong. The employee might feel exploited, and let that dissatisfaction show, poisoning the workplace atmosphere. Managing a family employee is only easy when it is not needed!Correcting and coaching a family member is a touchy area that can spark issues outside the office on the home front.

Family employees may have issues from home (arguments, rivalries, jealousies) that they cannot ignore when they work with the same people. Non-family employees feel out of the loop and less influential when they must compete with family members for the boss’s ear. They may also perceive unfair treatment compared to a family member, in terms of privileges or pay compared to competence and/or effort.

What should a small business do? Should it take advantage of the obvious benefits of depending on a trusted family member, especially when there are some tax benefits involved? Or should it avoid family employees to avoid the extra-difficult morale and relationship issues that result when all is not rosy? Are there some tools that a smart small business can use to employ family yet minimize the downside risk?

Yes, some techniques are available. The next two articles explain them.

What do you think? Do some tools and techniques for managing family employees work especially well for you?

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), and a SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. For information on the scope of Tom’s activities, see www.tom-gray.com. For more on SCORE services, see www.scorefoxvalley.org.

Management Techniques for Family Employees

by Tom Gray | on Jan 01, 2012 |  Comments

Family employees can be a problem as well as a blessing. See Small Business — Employing Family and Small Business: Employing Family – Techniques That Work. Establishing policies makes sense even for a small business. Address the problem once, write down the answer as a policy, and move on. Aside from job descriptions and a market-based compensation plan, other useful techniques include objectives, accountability, shared values, and even a major project approval process.

Agree On Objectives

Imagine you employ your spouse, and he or she does the finances. You want him or her to produce the end-of-month reports by the fifth business day, not the fifteenth. When you ask for that, the response is a litany of how he or she spends their time.

What is missing here is a list of goals to be accomplished, agreed to by both parties at the beginning of the year. Your finance person needs to deliver the reports when you need them.

They have to figure out how to do that, rather than telling you their problems and, by implication, asking you to manage their time. This is their problem to solve, not yours. You care about the deliverable, not how they manage their time.

The tool is agreed goals. Without them, there is no basis for the subordinate’s accountability.

Write Down the Company Values

The same idea can take the form of behavior expectations, commonly called “values”. These are “the way we do things around here.” Examples: we value teamwork; our integrity is never compromised; we deliver what we promise, to each other as well as to customers and suppliers; our behavior makes our colleagues proud.

It may seem silly to write down behavioral expectations, but it is most important when you employ family. Why? Because family members have a history of behavior outside the workplace, and they may expect to behave the same way at work – after all, you know them.

They may also believe there are no consequences for inappropriate workplace behavior if one is family, setting up a double standard when non-family employees are considered. The best way to handle this is a set of standards communicated (hence, in writing) before any problems arise. Like goals, these provide a basis for accountability and consequences.

Major Project Approval Policy

One other “policy” could serve small business well: a “major project approval policy.” A major project is usually a large investment, such as a marketing program or a new machine or moving the business. By thinking in advance about what would justify taking such a risk, you improve communications with any co-owner or family member who may be affected by the decision.

Prior definition of decision criteria can also help you as the decision-maker, bringing a degree of dispassionate logic to what may be an emotional issue, with hope warring against fear, or courage facing down prudence.

Problems with Policies

For a small business owner, the unfamiliar behavior here is thinking about potential business problems before they arise, and writing down a framework of expectations, or solution criteria. These owners normally don’t feel they have enough time to handle immediate problems, let alone anticipating issues that might come up in the future!

Also, they are not comfortable committing to written policies, because they know the future brings change and they will need flexibility. They might see policies as an obstacle to managing their future, rather than a tool for organizing their chaotic lives.

Managing employees is not easy, and family employees redouble the stress involved. Establishing and enforcing policies is the key to success: qualifications, job descriptions, shared values, objectives, accountability, market-based compensation, and a major project approval process.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), and a SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. For information on the scope of Tom’s activities, see www.tom-gray.com. For more on SCORE services, see www.scorefoxvalley.org.

 

13 Week Cash Flow Statement

by Tom Gray | on Jan 01, 2012 |  Comments

“Cash is King” in a small business.  A cash shortage is one of the hallmarks of a business slipping into trouble – a distressed business.

The owner’s first priority is to pay the vendors whose services keep cash coming in. Bank loans don’t do this, so the owner asks the bank to wait for its payments. In response, the bank wants to know the company’s prospects for paying in the future. It asks the owner to forecast revenue and costs, and predict cash flow using a 13 Week Cash Flow Statement. See 13-Week Cash Flow Model Creates Clear Communication Channels.

What Does a 13 Week Cash Flow Statement Look like?

The “statement” is a spreadsheet containing a column for each of the next 13 weeks, i. e., the next quarter of the year. Starting with cash on hand at the beginning of the period (BOP), on a weekly basis it adds cash expected to be received from outstanding invoices, from work in progress, and from new business in the next 13 weeks. Then it subtracts the cash used to pay for the variable costs for completing such work, and the expected overhead or fixed expenses to be paid during this period. The net is called “cash flow.”

The cash flow at the bottom of each week (end of period or EOP) becomes the cash on hand at the start of the next week (BOP). Thus the net at the bottom of each week is cumulative, showing all the expected cash-on-hand at the end of that week.

Moving from one column to the next is like turning the page in a checkbook register. The first entry is the cash on hand at the end of the previous week. Each week’s column is like the page in that checkbook register, with cash at the top, money coming in, money going out, and the cash on hand at the end of the week.

The Challenge for a Small Business Owner

Small business owners usually understand their expenses very well, and they know what is owed them for completed work and work in progress.

Their problem is forecasting new work and new revenue. Their bookkeeper is not a forecaster, and their accountant looks backward, not forward, so the cash forecast becomes the owner’s task. Unfortunately, the owner of a small business spends most of his or her time working in the business, not on the business. They normally rely on others to track the numbers.

When the owner has to do the forecast, they feel overwhelmed by the variety of possible work that might come in, and the uncertainty of what kind of work will come in during any given week. They know the bank is being reasonable to ask about their prospects, but feel frustration and resentment when asked to predict the unknown!

How does a small business owner predict revenue, costs, and cash flow on a weekly basis? Is there a secret formula? Probably not, but there are some techniques that can help you make a reasonable forecast for the coming weeks, whether or not your business is distressed and facing a cash shortage. We’ll describe them in subsequent posts.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), and a SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. For information on the scope of Tom’s activities, see www.tom-gray.com. For more on SCORE services, see www.scorefoxvalley.org.

13 Week Cash Flow, Part 2 – Forecasting the Knowns

by Tom Gray | on Jan 01, 2011 |  Comments

Uncertainty and the variety of potential developments is the challenge in preparing a 13 Week Cash Flow statement. But this task has some easy parts too. The first step is to forecast known revenue and costs – outstanding invoices, work in progress, and new work from proposals already submitted. This part of the process has three steps.

1. Invoices: Identify the invoiced amounts you have not received yet. Note how much you expect to receive in each week.

2. Work in Progress:  How much will you invoice for this work in progress? When will you send the invoice, and how much later will the cash payment be received? Your revenue is booked when the invoice is sent, and this shows up on the “income statement” or “P&L Report”. But for a cash flow statement, the important date (or week) is when the cash comes in. You cannot pay a vendor with booked revenue! You need cash.

This timing difference between invoice and receipt of cash is the most important difference between the income statement and the cash flow statement.

If you expect to pay out additional cash to complete this work in progress, be sure to add that additional expense to your predicted cash outflow for the coming weeks. Use separate lines (rows) in your spreadsheet to show the costs for work in progress separate from the costs of new work you have not started yet.

The typical rows would be materials, labor, and subcontractor expenses, any unusual shipping or packaging expenses, and any sales commissions. These are called “variable costs” or “costs of goods sold (COGS).”

3. Known Future Work: You may have already made a bid or proposal, or you intend to. This should be a third set of rows in your spreadsheet. For each of these jobs, use a separate worksheet to estimate the revenue, costs, timing, and percent likelihood of getting the job. Then you can use a summary on your master spreadsheet.

For this future work, you will need to make some realistic estimates. When will the customer decide? Should you assume he will take the price you bid, or will you need to come down a bit? When will you order supplies and when will you have to pay cash for them? When will you complete the job and invoice it, and when will you receive cash from the customer? If there are “progress payments” along the way, how much and when?

What are your chances for getting each of these jobs? You will multiply each of the revenue and cost figures by this “probability percentage” estimate, making your forecast a more realistic view of the prospects for the business.

Next you will estimate business as yet unknown. We’ll cover that in the next post. At this point you know the format of the 13 week cash flow statement, you forecasted the revenue and costs for outstanding invoices, work in progress, and likely new work you already know about.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), and a SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. For information on the scope of Tom’s activities, see www.tom-gray.com. For more on SCORE services, see www.scorefoxvalley.org.