Financials
FYI, for those that are looking to learn enough finance to own a business or to run the household better. Previously, I discussed my own lack of knowledge in this area here. Right now through June 5th the Corporate Finance Institute is running a special for 40% off. The coupon code is LEARNER4LIFE. I get no kickbacks or referral benefits whatsoever, but I signed myself up and thought others might be interested. Over the next year I will be furthering my financial education. The cost was ~$300 to get access for 1 year to 5000 lessons in over 100 courses. Personally, I have no desire to be become a finance professional, but do want to understand it at a level that allows me to better model the future and keep track of the accounting in a small business.
Quality of Earnings
The CPA I hired to provide a quality of earnings (QoE) report has provided me with a near complete draft, whose summary can be seen below. He strongly advises me to move the accounting basis over to accrual and from my understanding few small businesses at this range actually achieve accrual, most a hybrid system between cash and accrual. Personally, I understand cash basis as that is essentially how I run the household. The theoretical basis of accrual is described here, but it essentially allows you to line up expenses with revenues such that you know how much it actually costed to produce a widget. To take this suggestion seriously, it is my goal to get through a couple of courses before closing so that if I decided to I can switch the company to accrual basis as it has been run on a cash basis for over 30 years.
Summary from QoE
The Company has a sustained history of operating at a high level of profitability, although there has been essentially no growth in sales.
The Company does not engage in marketing or outbound sales activity.
The high level of profitability might be explained by the Company’s ability to provide premium products and services -- thereby commanding prices that produce premium margins – combined with the ability to only pursue and
maintain clients that value premium performance and are willing to pay for it.
The Company’s ability to produce high margins may be a double-edge sword, in that it may also be a constraint to growth due to a limited number of customers
placing willing to pay premium prices.
As new ownership moves forward with growth plans and new sales and
marketing efforts it should be mindful of the challenges associated with commanding premium pricing and account for this factor in marketing plans.
The fact that there is a concentration of much of the business conducted with a small number of customers poses a level of risk. We understand that the customer relationships – which have been in place for a long period of time – are largely institutionalized, and not dependent on the owner or other key individuals. To the extent this is the case, the risk is mitigated. Yet, risk remains due to the nature of enterprise level relationships. This risk factor makes growth and new customer acquisition all that much more compelling.
The profit margin has averaged 25% over the past 20 years, and the company has grown from $400K in sales to over $2M during that timeframe. For the past 3 years, it has remained relatively stagnant, and I hope that was due to the owner getting comfortable with that significant income, and thinking about retirement.
My goal is to grow the company by 5% or more per year in bottom-line revenue, while maintaining the current margins. To accomplish this, my current plan to do direct outreach to specific roles within specific companies that fit the current customer profile, but are not yet customers. This will be difficult, and at least for the first 3 months, I am not planning on doing any additional outreach as I come up to speed with understanding the business.