■ Have all foreseeable risks been identified? ■ Are owners in touch with industry peers regarding changing rules and reg- ulations? ■ Does the company have quick access to legal counsel that knows enough about the industry to guide the enterprise through changing federal and lo- cal regulations? From a financial standpoint, strategies should be in place that take into account unexpected regulatory barriers. Setting up adequate reserves and having the capa- bility to quickly add the impact of new regulatory guidelines into budgets and fore- casts may be the extent of a sound preventive finance strategy. If the organization is publicly traded, however, a process may have to be in place to communicate changes like these to the analyst community and shareholders in general, to man- age expectations and optimize stock price. In this case the finance strategy may in- volve retaining an investor relations professional or firm to spin unexpected news and requirements to the public. DOING BUSINESS IN FOREIGN COUNTRIES The new economy (as dictated by the Internet boom) has created markets where they previously did not exist while enhancing those that were once modest, at best. Companies in the United States are finding that penetrating markets in North America may not be enough to remain competitive with rival industry players. Burgeoning economies in Latin America, Asia/Pacific, and Europe are driving a changing world of market and cultural demographics. Before diving headlong into a foreign market, it is prudent to weigh the risks of participating in cross-border commerce with an upside potential. The Internet The chief driver of the new economy, undoubtedly, is the Internet. By providing cheap, (relatively) low-maintenance access to the global community, companies of all sizes and means can deliver products and services to once-inaccessible con- sumers. What is the cost of this unbridled access? Is the company exposed to local tax liabilities if it sells to customers in certain countries? What local disclosure rules are the company subject to? Is the enterprise violating trade treaties or laws by selling to the international community? Is the enterprise prepared to deal with local authorities in the case of trade or import levies? Could U.S. or foreign au- thorities force the enterprise to shut down its website or stop offering products and services? Any or a combination of these scenarios could have an impact on the fi- nancial health of the organization. What is the best way to strategize around such bumps in the road? DOING BUSINESS IN FOREIGN COUNTRIES 13 Brick-and-Mortar Operations To better address the issues of doing business in foreign markets, it is best to ex- amine the situation from a bricks-and-mortar perspective—that is, how would the enterprise function if it had a physical presence in a certain country? Having a physical presence in a country avails the company to advantages it would not have if it had no physical presence. Avoiding exorbitant tariffs and duties not to mention glacial import protocols are some of the major advantages of having a physical presence in a foreign country in which a company wishes to do business. With these advantages, however, come the responsibilities to comply with lo- cal tax and reporting rules. Regardless of the company’s status (as a subsidiary, dis- tributor, or manufacturing concern) in the foreign locale, foreign countries (with few exceptions) consider the company’s mere presence grounds to assess it as a le- gitimate tax-paying entity. This means allowing local authorities access to all books, records, and information systems for statutory review. It also means com- plying with all tax laws. Doing so could include definitions of revenue, expenses, assets and liabilities that differ from those of the United States. Lack of compli- ance with even the mildest of provisions could mean fines, penalties, or a cessa- tion of business. Additionally, accounting treatments prescribed by foreign bodies, whether by the countries themselves, by administrative bodies like the Interna- tional Accounting Standards Committee, or by a combination of both, must be understood and applied properly. In some cases, local GAAP rules and tax rules are one and the same; in other cases they may be different. Examples of country- specific reporting rules are: ■ Thin capitalization rules. Many countries require that certain threshold ra- tios of debt to equity be maintained. For example, if Germany requires that all companies doing business within its borders have no more than a 1.5 to 1 debt-to-equity ratio, any slippage below this ratio could deem a company bankrupt and require it to be liquidated. Companies often must institute drastic measures in circumstances like this, such as injecting cash into the enterprise or converting debt to equity. The solution required to address such a problem may be counter to the company’s overall strategy. ■ Hyperinflationary accounting rules. Certain countries with unstable economies require the revaluation of balance sheet and/or profit and loss (P&L) balances on a periodic basis to mitigate the impact of a weak local currency. Economies that are hyperinflationary have specific rules for revaluing balances in an effort to keep year-to-year comparisons of data ac- curate. This may include creating and maintaining specifically defined ac- counts on the general ledger. In Mexico, for example, this is called the B-10 calculation and is mandated for all companies that are traded on the public exchange. 14 DOING BUSINESS IN TODAY’S ENVIRONMENT Aside from reporting and tax rules, a company must take into account cultural norms and the potential for political instability. Other countries may deal with is- sues related to social costs (equivalent to Social Security in the United States), va- cation time, and employee hiring/firing very differently from what is done in the United States. Social costs may be significantly higher in foreign countries, some- thing that must be factored into budgets and forecasts. The norm for vacation time in some countries may be a minimum of six weeks or more per employee. Rules related to constructive termination (where employees are deemed terminated due to a change in work environment) play a huge factor in some countries, especially if a restructuring effort is undertaken by the U.S. parent company. Generous statu- tory severance also plays a factor in restructuring efforts. These costs must be taken into account in budgets and financial models, whether they are one-time charges or recurring expenses, especially when the viability of operations is considered. Infrastructure issues also play a role in doing business in foreign countries. The level of reliability of certain aspects of infrastructure vary wildly from coun- try to country. The condition of roads, public structures, water supplies, phone lines, and electricity ranges from excellent to poor depending on the continent, country, or city. It is not uncommon in some countries for phone lines and power grids to go down for extended periods of time. If a period-end closing of the books relies on the submission of data from a country with poor or unreliable phone lines, the closing may be held up or put in jeopardy, a particular concern for public com- panies with scheduled press release dates and filing deadlines. LITIGATION Litigation can have a direct and/or indirect impact on the enterprise. The impact of litigation filters down to the bottom line in the form of fines, penalties, inability to sell a product, or mandated recalls. In a more subtle way, litigation impacts the way an entire industry approaches a market or an individual company’s brand image. A perfect example of both the overt and the subtle impact of litigation on the enterprise is embodied in the Microsoft antitrust litigation, United States of America v. Micro- soft Corporation, 5 which extended from May 1998 to April 2000 (original trial). The economic fallout from this action has already been borne by Microsoft shareholders. Microsoft’s market capitalization declined precipitously as the initial verdict was read and penalties proposed. The real and most far-reaching impact, however, will be felt by smaller, existing software makers and consumers. By mandating a change to the way Microsoft produces and markets its operating systems, the U.S. Justice Department can significantly alter the landscape of the computer software industry. The wide-open, hypercompetitive software industry sought by plaintiffs in the case may come to pass, which could change the financial fortunes for many. LITIGATION 15 Litigation also can have a direct impact on companies that do not follow re- porting and disclosure rules. A good example is the case of Caterpillar Inc., a global manufacturer of heavy equipment. The company was subject to class action suits related to financial statements it issued in 1990. The lawsuits alleged, among other things, violations of certain provisions of the federal securities laws. The com- plaints alleged that company executives fraudulently issued public statements and reports during the period from January 19, 1990, to June 26, 1990, which were mis- leading in that they failed to disclose material adverse information relating to the company’s Brazilian operations, its factory modernization program, and its re- organization plan. In this case the lack of disclosure of potential foreign currency risk in its Brazilian operations led to shareholder lawsuits filed when the economy of Brazil hiccupped, adversely affecting the company’s financial statements. The precipitous drop in the price of the stock led to the lawsuits, which forced the res- ignation of key executives in the organization and led to other debilitating sanc- tions. The circumstances surrounding this case moved the SEC to issue specific guidance on disclosures in certain public filings. 6 Acute punitive damages for ex- ecutives are becoming more common as the SEC continues to get tough with those who manipulate accounting and disclosure guidelines for their own benefit. This means jail time. Phar-Mor, Bennet Funding Group, Lumivision, Bernard Food In- dustries, and California Micro Devices are examples of companies whose execu- tives served time for accounting/disclosure indiscretions. 7 The key point is recognizing the need to evaluate risk in the organization. For the small and emerging business owner, this may be a challenge. The need to rec- ognize the presence of risk in doing business and quantify it is the challenge of the finance organization. At the very least, reserves and insurance to cover potential litigation should be in place. However, as a growing business enterprise becomes more diverse in its offerings and the business environment becomes more com- plex, the finance organization must be suited to identifying and quantifying the risk associated with the direct or indirect impact of litigation. TECHNOLOGY NEEDS OF VENDORS AND CUSTOMERS The business owner must be in tune with suppliers and customers from an infra- structure perspective as well. The Internet has enabled business-to-business order- ing, which greatly enhances the speed and accuracy with which orders for merchandise and services are communicated. This paperless model for handling customers and vendors, however, may require attention to system and application interfaces. Collaboration of the two is becoming more and more necessary for businesses with common supply interests or those that participate in similar verti- cal markets. Having adequate platforms and interfaces is a must to enable these tremendous cost-saving models. 16 DOING BUSINESS IN TODAY’S ENVIRONMENT Participating in these paperless models often opens up a whole new world of stewardship when it comes to systems maintenance. The intricate interdepen- dencies of different companies and their interfaces or applications requires an all- or-nothing participation commitment. If one component/participant goes down, how does this affect the rest of the consortium? How vulnerable to viruses or dam- age is the consortium? Can a single participant crash the whole system? Issues like these must be addressed up front before such an endeavor is sought as a cost-savings solution. Business owners must be willing to commit time and dollars to such solu- tions in an amount equal to that of other participants. EMPLOYEE NEEDS Some of the most challenging decisions made by small and emerging company owners relate to employee-related benefits. Health insurance, life insurance, and 401k plans may be a part of the business owner’s plan to retain top talent and fos- ter loyalty. These plans have a cost, however, and the business owner has a re- sponsibility to ensure they are appropriately funded and suit employees. Do these plans require a one-time outlay of cash to set up? How heavy will the funding ob- ligations be over time? Will the funding obligations change over time? Is the com- pany properly reserved to fund a huge liability to the program if needed? Employee benefit plans should be a part of any small and emerging business, but the business owner must be aware of the financial obligations of the particular programs that have been or will be put in place. The headache of switching programs for finan- cial reasons may create confusion and bad will rather than peace of mind among employees. STRIKES Depending on the industry, labor strikes may impact the company either directly or indirectly. A company whose operations rely on organized labor (or other com- panies with organized labor) may be vulnerable in the event of a work stoppage. Work stoppages due to labor strikes could result in unfilled orders, slow returns, and supply chain slowdowns. For many small and emerging businesses, the impact of strikes may be more indirect. Merchandisers that rely on the Internet to reach customers may depend exclusively on the post office, UPS, or FedEx to deliver merchandise to customers. What type of provisions have been made to guard against the impact of strikes at courier companies? If a strike cuts off delivery to customers, how long could the company hold out? What is the run rate on cash? The company should have as a part of its strategy a finance model that addresses such a scenario. STRIKES 17 NATURAL DISASTERS All companies are subject to risk of some sort, not the least of which are acts of na- ture. Whether it is hurricanes in the Southeast, floods in the Midwest, or earth- quakes in the far West, the most extreme circumstances must be considered when it comes to planning a business strategy. Provisions should be made not only for the operational aspects of the business in the event of a natural disaster (manufac- turing, distribution, service support) but for the repository of financial data and the data flow dynamic as well. SEC filings, state and federal tax returns, debt compli- ance, and the like must be attended to regardless of circumstances. Although au- thorities make provisions for companies affected by such events, rarely if ever do they forgive a reporting requirement. In this age of electronic data storage, there is no excuse for losing all financial data and the capability to gather it in the event of a natural disaster. Many companies in high-risk areas have insurance to guard against business disruption and physical plant damage in the event of a natural disaster. However, the life-blood of the organization—the ability to convert data to knowledge—must be preserved in all circumstances. Does the organization back up key data (finan- cial or otherwise) daily? Is the data stored in an alternate offsite location? If the or- ganization operates in a high-risk area, is this storage site in an alternate, less risky geographic area? How about provisions for the finance function itself to continue in the midst of a devastated area? It may take something less than a disaster to im- pair a company’s ability to function. For businesses in the southeastern United States, heavy rains and flood conditions are common during the late summer and early fall. If offices are flooded and computer systems are damaged, how will the company continue to bill and service customers? How will it close the books if such an event happens during year-end? Do key personnel have alternate commu- nication and workstation capability? Has an alternate “hot site” or rendezvous point been designated in the event of disaster? Does a plan exist to mobilize key finance personnel to continue with crucial finance tasks? TEN QUESTIONS This book provides guidance and insight on finance infrastructure, policies, and the culture of analysis. What this book does not provide is the inclination to act. The following 10-question self-examination serves to drive home the need to strategize the finance function. 1. How much time spent on finance matters is quality time? Are the deci- sion makers really making decisions or performing clerical finance tasks? In a survey of over 1,000 large and small companies, Hackett 18 DOING BUSINESS IN TODAY’S ENVIRONMENT Benchmarking Solutions, a consulting group in Hudson, Ohio, found that throughout the 1990s, finance managers were spending an increasing amount of time on clerical tasks such as billing, compliance, and book- ing journal entries and less time on decision support, planning, and man- aging the finance function. They found that from 1996 to 1999, the amount of time spent on transaction processing increased from 41% to 47%. In that same time period, the amount of time spent on strategic planning, business performance analysis, and cost analysis declined from 18% to 16%. 8 Because the business executive’s time is at a premium in the critical formative years of the business, it is worth the effort to set the stage for a well-oiled finance function that minimizes non–value-added tasks. Are the prime movers of the business making decisions or crunch- ing numbers? 2. How often does the organization focus exclusively on financial/accounting tasks? Closing the books at the end of the month should not paralyze the organization. The objective should be to make a period-end close a non- event. More time spent on pulling the numbers together means less time for analysis and interpretation of the numbers. This point applies to non- standard information requests as well. The finance function should be able to respond to all standard and (reasonable) nonstandard information re- quests relatively quickly. How well does the organization’s finance func- tion do this? 3. How reliant is the organization on financing? Growing a business with other people’s money is what is great about being in business. The down side—it is other people’s money, and strings are attached. Depending on the type of financing in place or being sought, the organization may be subject to audits or reviews that are a matter of law. Can the finance func- tion hold up to scrutiny? If the validity of numbers is in doubt, the finance function is not adequate and the organization is not ready to use other peo- ple’s money to grow the business. 4. Does the flow of cash into the business move in proportion with earnings? Hardcore analysts look at these two major indicators of company performance—cash flow and earnings—and draw an overall conclusion on the health of the organization. If both indicators move in tandem over time, that is good news. If they diverge for any significant length of time, then red flags pop up all over the place. Without getting too technical, the business may have good reason for earnings and cash flow to diverge (investment in infrastructure may be one reason). The important question to ask is: How quickly does revenue translate to cash? Does the organiza- tion have to wait an inordinate amount of time to collect cash from cus- tomers? This is often a problem and businesses do not even know it. Good customers may not be good after all if they deprive the business of cash TEN QUESTIONS 19 owed on the sale of products and services. In the spawning years of any business, optimizing cash flow is a must. Does the finance organization have the capability to track this crucial indicator? 5. Does the business have a manufacturing/supply chain? If the business is a manufacturer, how well is it using technology to streamline the man- agement of data related to the supply chain? “Managing the supply chain” refers to maximizing margins on goods sold rather than managing inven- tory. If the organization has not considered initiatives such as purchasing supplies online or sharing product purchase forecast reports with vendors online, it may be letting dollars slip through its hands. Has the business owner evaluated and strategized the supply chain? 6. Is the industry in which the business operates reliant on the Internet? According to the Small Business Administration, small companies that rely on the Internet for doing business have higher revenues than those that do not. Internet-savvy small businesses average nearly 40% higher revenues than the average of all small business revenue. 9 For all small and emerging businesses that are Internet ventures, it is no secret that the busi- ness environment is changing on a daily basis. These business owners must ask themselves if they are prepared to change their business model on a day’s notice. In addition, they must have a feel for how well their data gathering, processing, and analysis tools suit their changing information needs. Can the finance function change its focus at the drop of a hat? Be- ing able to thrive in this environment will mean being able to gather the particular data needed, when it is needed most. How well can the finance function react to the organization’s changing needs? 7. Does the company rely on nonfinancial databases? The organization may be juggling a myriad of databases that gather both financial and non- financial data. The organization’s marketing department may be presiding over a substantial cache of data that grows daily. Is the finance function plugged into this? Are business owners enabling forecasting and budget- ing by accessing this nonfinancial data? The ability for the finance organ- ization to access all data gathered by the enterprise (financial or otherwise) creates valuable synergies for the finance organization and magnifies its impact on operations. How well has the organization har- nessed this data? 8. Is the organization a new player in a new industry? Being the new kid on the block is one thing, but starting up a business in an industry that is relatively new is quite another challenge. With nothing or no one to mea- sure itself against, the organization will have a difficult time establishing meaningful metrics and benchmarks for growth. The need to be transpar- ent (translate easily to financial statements) is more important than ever if 20 DOING BUSINESS IN TODAY’S ENVIRONMENT the business is alone in a new industry or niche. The challenge of the small and emerging business owner will be to navigate a nonstandard season or fickle marketplace while balancing seed money and other financing alter- natives. Getting a hand on the pulse of the organization and getting it quickly will require a robust forecast and budget function as well as an ag- ile closing process. The small and emerging business owner must deter- mine if the finance function is up to the task. 9. How does the small and emerging business owner visualize growing the business? Do the owners and executives subscribe to the model of growth through acquisition, or are they more comfortable with the organic (internally generated) growth model? If they subscribe to the former, are they prepared to adapt a target company’s finance model to theirs? If the business is predicated on an organic growth model, what metrics (meas- ures) and analysis models are being employed to reach growth goals? As a practical matter, most business growth strategies should employ a fair mix of organic and acquisitive growth initiatives. If financing will play any role in growth strategies, having a sound data flow dynamic will be imperative to maintain compliance with loan covenants and financial statement deadlines. Is the organization prepared for this? 10. How savvy is the management team? As a small or emerging company, chances are the management team has a broad skill set with no consistent degree of depth in multiple areas. Most likely, the management team is heavy on the operations side, which can result in acute issues on the finance side going unaddressed (traditionally these are viewed as an ad- ministrative or back-office function). Waiting to deal with finance and ac- counting issues until they become a crisis will cost the organization in both dollars and/or lost opportunities. It is possible, however, to take steps in the early years of the business to set the stage for sound finance func- tion development. Ignoring this part of the business in its infancy may put the organization’s decision-making, operational strategies, and customer relationships at risk. The organization’s management team must ask itself: How much attention has been given to the finance function? FINAL THOUGHTS Evaluating the current state of the organization and the finance function that supports it can be a sobering exercise, especially when it relates to a business entrepreneurs/owners may have spent their lives building. If the 10 questions above have cast doubt or concern on the state of the finance function and its ef- fectiveness, let this book serve as a primer for organizing thoughts and developing FINAL THOUGHTS 21 a sound strategy for finance function development. The first step in creating a sound finance strategy is recognizing the need to develop one in the first place. The next step is to understand what the finance function is and why the need to strate- gize is so important. NOTES 1. Small Business Administration (SBA), Office of Advocacy, Washington, D.C., www.sba.gov/advo. 2. SBA, Office of Advocacy, Washington, D.C., www.sba.gov/size/guide. 3. Ibid. 4. Jake Wengroff, “SEC Scrutiny: They’ll Be Watching,” CFO, July 2001, p. 12. 5. United States of America v. Microsoft Corporation, U.S. District Court for the Dis- trict of Columbia, 2000. 6. In the Matter of Caterpillar Inc., Exchange Act Release No. 30532, March 31, 1992. 7. Tim Reason, “Jailhouse Shock,” CFO, September 2000, p. 113. 8. Eric Krell, “Finance Managers on the Wrong Track,” Business Finance, July 2000, p. 10. 9. SBA, www.sba.gov/advo. 22 DOING BUSINESS IN TODAY’S ENVIRONMENT [...].. .2 FINANCE FUNCTION DEFINED KEY TAKEAWAYS ■ ■ ■ ■ ■ ■ ■ Understanding the basic tasks of the finance function Understanding the definition and purpose of the finance function Distinguishing between two major components of the finance function: concrete components and soft components Recognizing traditional perceptions of the finance function and how to overcome them Understanding how and why... the finance function with operations Understanding how to preserve the dynamic nature of the finance function and why it is important Understanding why the finance function must preserve the integrity of financial representations of the company FINANCE FUNCTION IN ACTION Conceptualizing, implementing, and maintaining a finance strategy requires an understanding of the finance function itself This function. .. budget and forecast data in a timely manner is key to achieving an optimal stock price and market capitalization for the enterprise This aspect of the finance function is no less important for small and emerging businesses that are not publicly traded Understanding raw material needs, personnel needs, and expansion requirements will force the small and emerging business owner to thoughtfully estimate their... part of the task of finding the right finance professionals What is the going rate? What skills are needed? When it comes to providing the small and emerging business with the “human” aspect of the finance function, overstaffing can be just as damaging as understaffing FINANCE FUNCTION DEFINED The finance function consists of the people, technology, processes, and policies that dictate tasks and decisions... developing a sound finance function may be the traditional perception of finance and accounting The erroneous perception of the finance function as the meticulously slow and detailed process that yields soberingly bad news of past performance must be addressed The reality is that the finance function must be up to the task of steward of the most valuable data the enterprise will encounter The responsibility... able to change as the business changes A business that reorganizes the way it manages products, people, or geographies relies on the finance function to do the same Can the finance function gather and process data along new geographic lines? Can it change the way it captures data on products and services? The finance function must change and adapt to remain relevant The agile finance function is also... defined than others The finance function serves as the foundation for virtually all aspects of the business—from gathering data and converting it to knowledge, to performing due diligence on expansions, to disseminating financial data to the general public So what does the finance function do? Many aspects of the business are prompted, driven, or dependent on the finance function However, some of the following... function, eventually issues in the business itself or business environment will demand them For example, infrastructure may suit a small and emerging business in the short run, but increasing demands for information and new ways to serve customers may necessitate change in this area Absent the vision for development or the strategy for addressing future data needs, the finance function always will be a... save the money, some other considerations for employing a payroll system include direct deposit, stock purchase, 401k and retirement plan deductions, and benefits withholding For many business owners this is the first hurdle in developing the finance function Financing Financing the company’s operations may be the single most important aspect of the finance function for the small and emerging business... best suits the organization in the near, mid-, and long term, is crucial when dealing with financing needs These issues are an integral part of the finance function 28 FINANCE FUNCTION DEFINED Collecting and Paying Taxes Regardless of the size or form of the company, the obligation to comply with tax laws is omnipresent Whether it is compliance with federal, state, or local laws, the finance function . OF THE FINANCE FUNCTION For the small and emerging business owner, the greatest barrier to developing a sound finance function may be the traditional perception of finance and account- ing. The. synchronize the finance function with operations. ■ Understanding how to preserve the dynamic nature of the finance function and why it is important. ■ Understanding why the finance function must. deter- mine if the finance function is up to the task. 9. How does the small and emerging business owner visualize growing the business? Do the owners and executives subscribe to the model of growth