Thursday, July 19, 2012

Earning The Carrot

A development for many companies in a rather challenging economy is how to keep your operating expenses low yet, still provide compensation to employees that both keep them motivated and compensated for their efforts.

            The "Carrot" in front of performing employees has been a staple of many business models. But, in a bad economy it has become even more important. Many companies need to hit their profit numbers even during hard economic times. All the while, management needs to be kept motivated and focused on managing the company. Companies also need to provide for a reward system that compensates good managers for creative efforts that trickle down to bottom line profitability. We all know business profits flow from the top of the "profit and loss" statement in terms of sales revenues but, in hard times when sales are flat, profit can also flow down from trimming operating costs and by creating greater efficiency.

            One effective measure of performance I have had the opportunity to work with is  the concept of EBITDA. EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization.  In theory it is a profit and loss statement that is the representation of everything management can be held responsible for. Typically, in many companies middle management does not have any control over interest, taxes, depreciation and amortization. But in theory everything else they do control. Once EBITDA is determined, then a percentage profit sharing plan can be calculated and distributed to eligible management if, they achieve target percentages.

            Depending on the company, the calculation of EBITDA can be adjusted for various factors that would negatively impact the comparability of EBITDA from period to period.  Thereby, making profit share calculations more stable. For example a company that is forced to make significant investments in repairs and maintenance to operating equipment could exclude those expenses as  part of their EBITDA in order to truly show management efforts.  At one client I had the EBITDA calculation changed from quarter to quarter depending on circumstances.  Both management and the owners handled the calculation with fairness and bonuses were routinely paid.

            One very important factor to note is each company that contemplates using EBITDA needs to have a good base line financial reporting system. You need to determine that point of reference from which to begin tracking management efforts and you need to establish clear cut and obtainable goals.

Accountant or Bookkeeper?

By definition bookkeeping is the recording of transactions into books and records held by some entity. Typically a business but, it could be any activity that involves tracking of money, quantities etc. Bookkeeping is actually a component of accounting. Accounting is a much broader term that may include financial reporting, analyzing financial information, verification of financial information, tax reporting just to name a few of the areas under accounting. To some degree a bookkeeper is to an accountant what a law clerk is to an attorney. Or perhaps what a nurse would be to a doctor.

            Unaware of this huge difference many people, even successful business people, unknowingly insult their accountants by referring to them as bookkeepers. Of course this could also go the other way where business people think their bookkeepers are accountants.  All of this is rather intriguing because when someone faints and drops to the floor like cold salami , rarely does one say; is there a nurse in the house? You don't here people say, I am going to have my law clerk sue you!  So why is it that when people have financial and accounting problems they think they need to get a better bookkeeper?

            A look at the financial statements of any publicly traded company will show the name of the Certified Public Accountants who prepared the reports and are attesting that management has carried out their responsibility in a fair presentation of the financial statements to the public.  Accountants employ rules that are commonly called "Generally Accepted Accounting Principles" or GAAP as the guidelines of how transactions should be accounted for and reported. In addition accountants employ " Generally Accepted Auditing Standards", or GAAS to make sure that audits are performed according to professional standards.

            Accountants play a very important role in giving financial statement users more reliable financial information from which to make business decisions. Decisions on how to invest, whether to make a loan or simply how well management does what is says it will do. In our capital markets money is allocated to businesses were management performs. It allows banks to make loans to companies that can repay their loans. In small businesses accountants also play a very important role. They help management make better business decisions based on information provided by their accountants.  Accountants, help in the compliance of loan covenants, tax laws, the payment of taxes just to name a few areas of importance.  Another perhaps, more widely known role accountants play is the role of trusted advisor.  A position earned after years of training, experience and demonstrated honesty and integrity.