Economics of Scale

EXECUTIVE SUMMARY

Faced with a major piece of new business, many clients find they instantly need more equipment, space, inventory, people and working capital. They must obtain capital quickly while simultaneously managing the other, physical aspects of the total opportunity. Many entrepreneurs are accustomed to pushing rather than managing to get things done, but even excellent financing can be lost through poor management. Good management can help clients successfully achieve goals that expand their capabilities. In extreme-growth situations, CPAs have to help clients focus on the business priorities. Start by listing the company’s immediate needs and working out what has to be done in what order. Flexible solutions can be a great help —for example, the CPA firm can take charge of receivables and disbursements to ease supplier concerns. Investors are reassured when the business communicates its progress frequently and thoroughly; that’s a task CPAs can ably perform for clients. CPAs can help get the right people. A strong accounts-receivable person can ease confusion. Timely and accurate financial reporting is vital since everyone has to know as soon as possible how well or poorly the business is doing. CPAs who consult on extreme-growth projects must adhere to ethical standards, know business planning in its classic forms, understand compliance regulations and have the ability to be assertive with and for the client. Carl J. Lacher, CPA, is president and a founding partner of Lacher McDonald & Co., CPAs, Seminole, Fla. His e-mail address is carl@lachercpa.com .

When clients land a really big opportunity, it rarely is unalloyed good news. To fulfill a supersize order, companies often have to scramble to ramp up and their risks increase dramatically. In “extreme-growth” situations huge orders create problems—from financing to accounting, taxes and human resources—for modest operations. Here are pointers to help clients secure capital, resources and management skills to meet suddenly escalated demands, along with real-life details from our firm, Lacher MacDonald & Co., in Seminole, Fla.

KEY FACTORS: CAPITAL AND MIND-SET
A Faced with a major deal, small companies may instantly need more equipment, space, inventory and people to do the job. Their working capital, adequate for existing operations, is insufficient for such growth; they need to obtain new capital quickly while simultaneously managing the physical aspects of the opportunity.

Psychology is a factor, too. Entrepreneurs are accustomed to pushing rather than managing to get things done—but even excellent financing can be lost through poor management. Good management and advice, however, can help clients successfully achieve goals that expand their capabilities. CPAs can assist with staffing, accounting and treasury functions and even become a liaison to a major supplier.

HOUSEWARES DEPARTMENT
Two years after we fired a client for nonpayment, its management came back to request our help with an opportunity beyond its “wildest dreams.” The company had hung in and had at last won a bid to supply aprons and a few related dry-goods items to a big box store. Its revenues would increase tenfold in two years if it could deliver.

We agreed to help, but the company’s payment history was a complicating factor. We set a limit on how much our firm would carry in accounts receivable; anything unpaid for more than one year would impair our independence. The big box store’s requirements were Draconian as well: It required delivery within 10 days of placing an order, including the initial one, and would penalize mistakes in shipping and/or documents by reducing the amount it paid.

WE WENT TO WORK
A plan always helps to banish uncertainty, so the order of business was to:

Help the owners focus. First we helped the owners sort out the priorities. We created flip charts of the company’s immediate needs and worked out what had to be done in what order. Our firm remained in daily contact and averaged four face-to-face meetings with the owners per week as the engagement progressed.

Be flexible about solutions. The company had no up-front capital and also needed inventory, physical space and equipment. The first big fix came when the owners found a supplier who agreed to accept payment when the company was paid, with the important stipulation that payments be remitted to our firm; we would split the funds between the supplier and our client. An attorney helped us shape an agreement specifying that we bore no legal responsibility for the funds received.

We established a dedicated bank account that was the client’s property into which we put all receipts and from which we made the split disbursements. We never mingled this project money with the firm’s or with the client’s general operating accounts, over which we had no control.

Communicate thoroughly and widely. More working capital surfaced when a local group of retired businesspeople became aware of the project and offered the company a loan. This provided desperately needed funding for equipment and was the catalyst that launched the project. The group’s primary condition for participation was a quarterly report from the client, including a narrative description of business progress, which we helped the owners write.

Help the client negotiate. We learned early in the project that helping to communicate the financial details between our client and third parties would be our greatest contribution to a successful outcome. The client was too busy with operations while we had the advantage of being impartial outsiders who were able to speak the lingo.

One of the client’s problems, for example, was that its existing facility was woefully inadequate. In fact, delivery of initial shipments was possible only because a severe drought let the company stack boxes on its front sidewalk for the freight service pickup. We helped the client negotiate a lease for a warehouse/office facility. It wasn’t perfect, but it was a major improvement over the sidewalk.

Point the client in the right direction. The big box store ordered, canceled and had problems with the items; it returned one apron model and took one case as a credit. We convinced the client that hiring a very strong accounts-receivable person could stop the confusion and suggested it run an ad in the free neighborhood paper to attract capable local people. (In our experience, such papers make a good resource for filling nontechnical positions). The client took our advice, found someone—and its collection experience with the big box store improved dramatically.

Calm fears. The supplier frequently was fearful about its accounts receivable and inventory, so the client asked us to visit its supplier’s big-city office several times to allay any concerns. On behalf of the client, we told the supplier, “If these millions of sales dollars are not worth the risk, then kill the deal—but you are being treated honestly.” Our presence reassured the supplier, who needed to put risk vs. return into perspective.

Our client did every inventory count, which matched an almost full sample done by the supplier. It was an added challenge to work with people who were very suspicious—and prove their concerns groundless.

Get the right help. Timely and accurate financial reporting was vital since we all had to know as soon as possible how business was going. We helped the client recruit its controller by looking in our “resumes for clients” file. We told her it would be the experience of a career and, to this day, we all agree. She had financial statements to us the first working day of the month nearly without fail—historical financial information was not ancient history.

HAPPY ENDING
The client found the financing, the space and the supplier. We provided the management consulting, business planning and help with communications to make the paperwork side of the equation work. We shared in the delays, victories, shipments, hirings and firings. Ultimately, the supplier bought the client. We were paid in full for our work, and the project was one of the most interesting of all our careers.

Our firm’s takeaways from this project included these lessons:

Informed but dispassionate communication with company outsiders such as investors and suppliers is a vital service CPA firms can offer.

Strong control and reporting are best achieved by helping the client hire the right people for the jobs.

A CPA firm can serve as the central point for collections and disbursements to satisfy all parties.

MEDIA UMPIRE
Along these same lines, our firm had another major opportunity—management consulting for a start-up television station. Our services included providing a forecast and attending almost all of the client’s board of directors meetings for 12 years. Frequently, we injected independent thinking that brought about changes in direction or cooled emotions before they could escalate into problems.

Starting out, we recognized the client needed:

Planning. The group of founders had the advantage of possessing significant radio broadcasting and business management experience. But the issues that arose early on were daunting: Could they obtain the licenses, a combination of locations for remote transmission with urban administration and attract the right programming and advertisers? This was a major task for the group but also a giant opportunity.

The CEO focused on the dual nature of the opportunity: first, to achieve maximum operating success with limited resources and, second, to position the station for the best deal when a buyout opportunity appeared.

Documentation. The client had funding for the initial work, but needed to raise capital to go on the air. We helped build the spreadsheets for the station’s potential revenues and expenses, which ultimately became the forecast. We projected how much it would cost to start the operation—a figure necessary to enlist investors. We also looked into securities issues by bringing in an attorney who provided an excellent set of guidelines. We held many meetings with the CEO and top executives on the many changes.

Communications liaison. Our firm’s work to improve company communication was as important as our accounting input. As outsiders, we could see the operating team lacked the time to address the information needs of the investor group; the managers—although highly experienced in broadcasting—were so busy that investor communications could easily have slipped. We witnessed several shareholder meetings that started acrimoniously and ended harmoniously.

The CEO was a receptive person, and we told him when we saw the need for improved communication. We had attended so many business meetings and teleconferences that we could cite for him specific examples where he had shown great skill at communicating to investors and others.

Adaptability. The station’s credit policy raised a unique issue. Revenue was vital; super-strict credit policies could kill the business and, hence, were not an option. The station took on some poorer advertising accounts to initiate a revenue stream, but as its position strengthened it was able to attract more reliable customers. This constant blending toward the middle to minimize bad debts was a key component of the company’s success.

Firm financial management. When a board member found a qualified controller and the station asked for our opinion, we voted emphatically “yes.” He improved controls, reporting and timely flow of information to management and was a valuable addition to the team.

Complex debt settlement. Ultimately, the station was sold. Tax planning was only part of the project. The corporate involvement included vendor and customer claims that could not be handed over to a buyer. The client formed a trust to handle these claims after the sale.

It was interesting to watch as the owners collected on claims and as claims against them were settled in their favor. The tenacious CEO had fostered a transparent climate and then assertively stood his ground where necessary. Good information paid off. We worked with management to distribute the funds and close down the trust, a process that took more than two years.

Along the way, we were offered an equity position but refused it to maintain our independence. Later several owners told us how much they respected us for our position. It was one of our best decisions.

We shared the experience of this company’s coming to life and struggling through the first years. It was truly a career-building and exciting experience for everyone involved. Our firm’s takeaways from this project included the following:

Informed, dispassionate communication with people outside the management team, again, was a vital service.

Working with knowledgeable managers from a variety of backgrounds (many of whom we would not otherwise have met) was an experience to value forever.

Good documentation empowered the client to hold its positions and satisfactorily settle any claims outstanding at the date of sale.

» Practical Tips

Be a go-between: Communicate clearly to company outsiders as well as owners. Help the client hire the best people for financial control and reporting. Suggest the client put an ad in a free neighborhood paper to attract highly capable local people for nontechnical positions. Recommend a trust for a complex post-sale debt-settlement process. Make sure clients maintain good documentation.

PRACTICE OPPORTUNITIES
When a local client has the chance of a lifetime, CPAs can be its best advisers. Like our firm, you can be a sounding board for clients who need guidance and help to nurture their success. Major projects require thinking outside the compliance-only box and an understanding of business management based on wide-ranging experience. Such projects are more than just debits, credits and taxes—they offer the excitement of challenge. Our clients’ technical capabilities have landed the deals; we’ve helped them make it work—and everyone has won.