Rules of thumb for loans

I had a frank discussion with a commercial lender yesterday and he gave me the following tidbits of information that may prove useful to some business owners.

He's looking for a 120% coverage ratio on business loans. This means that there is enough cash left from operations to cover 120% of the loan payment. If the entity is a passthrough (S Corp, sole prop, or partnership) the 120% coverage applies to both personal and business debts when everything is grouped together.

On soft lines of credit (those not secured by hard assets such as equipment or real estate) he determines that maximum line amount by adding 75% of receivables aged 90 days or less and 50% of inventory. Sometimes the receivables measure drops to 65% of outstanding balances aged 90 days or less.

Some banks quote line amounts based on revenues, while others will use coverage ratios. I thought it was interesting to hear this approach as well. Let me know if this information was useful.

Focus on markets, then products

A couple of years ago I broke down and bought an iPod. However, if your looking for a cool playlist for your next party you're better off grabbing my wife's gadget than mine. That's because most of the 4GB of audio on my iPod is podcasts. I'm a podcast junkie and use the media in my car to stay up on various trends and speakers. This morning I listened to a podcast from the Stanford Technology Ventures program (which I highly recommend) where Andrew Frame talked about 10 rules for starting a company. The most interesting thing he said was that you should focus on markets before products.

I think this is brilliant! Mostly because I've been telling clients this in one form or another for a long time. We do business with a lot of startups. Most of them have new, innovative products or a different take on service delivery that really is unique. However, they almost always fail to validate their concept with the market. A few months ago I was watching the TV show American Inventor and the judges repeatedly ripped folks who never asked the question "How big is the potential market for this product." Frame, a successful entrepreneur, started his most recent venture in the middle of one of the fattest markets on the planet, residential phone service (a $100 billion industry).

Don't get me wrong. I'm not suggesting you go out and spend tens of thousands of dollars on a market research firm to validate your concept. You don't have to. I will give you an example. I was recently asked to help develop a business plan for a type of medical diagnostic clinic. The client had done research on build out costs, pricing, insurance reimbursement, salaries and wages, and equipment costs. He had also selected a market to start the practice. We sketched out the makings of a proforma financial and the underlying assumptions in a few hours. Then I spent 2 hours on the web doing some market research. Here's what I found.

1. There's a national accreditation body with a web site that lists all of its members by state.


2. By cross referencing the state list with county demographic data I determined that it takes a population of about 200,000 to support one accredited facility.


3. The selected market has a population of 123,000.


4. Non accredited facilities exist, but appear to have very different operational models from the one outlined with the client.

So the lesson learned, again, is that a little time spent focusing on the market data (rather than market anecdotes such as "nobody else is doing this in the area") is time well spent. In this case we will need to revisit the choice of market or change the operational model before proceeding. While it would have been nice to know this before the financial research was done it's still better than sinking 400,000 into an enterprise that is doomed to fail from day one.

Ideally, you should focus on large markets or small markets that are completely unserviced. Get some hard data or hire someone who can help guide you in the right direction. CPA's and business consultants who specialize in startups are worth their weight in gold when it comes to keeping you from throwing money away. Your new venture will have a much better chance of getting off the ground if you know the size of your market and the potential impact you can have on it.

Non-financial measures

At a minimum businesses should have financial measures. In their most basic form these financial measures are comprised of a balance sheet, an income statement and a statement of cash flows. We work with many of our clients to build a one page, one year forecast that encompasses all of these. But what happens next?

Businesses are increasingly turning to their CPA's to help assemble non-financial reports that detail progress in areas such as customer service, employee retention, capacity, market risk, etc. What has been interesting is that it is usually the exercise of financial forecasting that highlights the need for these non-financial measures. Those who know me know that I am a big fan of forecasting. That's what our entire mission statement at Axiom is built around. But what most people don't know is that I love forecasting so much precisely because it REQUIRES business owners to understand, explain and predict the non-financial factors that drive their numbers.

Over the next few years non-financial measures will become the buzzword in accounting and CFO circles. The international accounting firms and their consulting arms are already beginning to bang this drum and it's just a matter of time before the message percolates down to small and medium size businesses. However, you don't have to wait to see benefits from this unique way of examining your business. All you have to do is find a knowledgeable CPA and have him or her assist you in building a detailed financial forecast. During this exercise you will ferret out the non-financial details that drive your numbers and you'll have a much better understanding of where your success comes from. The really insightful business owners don't stop at the forecast. They put in place systems to measure these non-financial factors on a regular basis (weekly or monthly). That way they measure and pay attention to the source of success.

Open Book Management Objections

When we talk about Open Book Management with clients or business owners I'm used to getting objections. This webcast covers the most common types of resistance I hear.

Have computers contributed to a bloated tax code?

Over the last week we have been working on a project that requires us to prepare several very old tax returns without the aid of tax prep software. The beauty of the US tax system is that everything you need to prepare a return is freely available from the IRS web site (historical forms, instructions, tax publications, even the tax code itself). In reality, it is difficult for me to imagine a layman preparing anything but the simplest tax return manually. This just goes to show you that information is NOT power.

I'm convinced that part of the mess we're stuck with that is the US tax code is a bi-product of the widespread availability of computing power. For something like $25 anyone can walk into a retail store and purchase TurboTax. This is a great program! For $25 you get the ability to perform in an hour what could take a trained professional 4 or 5 hours to do manually. My own opinion is that IRS should purchase a copy of TurboTax for every taxpayer and send it to them in a gift wrapped box. Without something like TurboTax IRS has no hope of collecting the correct amount of tax. The current tax system is so full of exceptions, alternative calculations, recapture provisions and phaseouts that it is impossible to expect most taxpayers to get it right. Remember, the average US adult reads at an 8th grade level. If we all had to prepare our returns manually one of two things would happen a)the Treasury would go bankrupt because we would get it wrong and IRS has no hope of catching so many errors or b)the US populace would riot at the prospect of paying grossly inflated taxes because they couldn't figure out how to claim all the deductions and credits they're entitled to.

We focus mainly on businesses rather than individuals so this debate is somewhat academic to my standard of living. I do think individual tax advisers are important and worthwhile so long as they add value in the form of planning and education. It's just unfortunate that low cost tax software has enabled legislators to cram more and more complexity into a tax system that defies comprehension more times than not.