MONEY 118 - ACCOUNTING

THIS IS MY 118^TH BLOG ON UNDERSTANDING MONEY TOOLS

In the last blog we quickly analyzed a publicly traded national retailer.

Since writing, a couple friends who read my blog asked me what the most important things would be to change in these dated companies.  To this I commented, first predict where your markets are going and watch demographics, secondly know your inventory and controls well.  Place an individual over backroom inventory who is responsible for accuracy and efficiency utilizing top software programs.  Thirdly, get modernized and set standardizations with all stores.  I totally understand why companies buy old companies,  they are locking in market share trying to keep competition out.  Walgreens used to be one of the best in higher density areas having a location on a one mile grid.  Transforming into the 21^st century costs a lot of money, however in the long term will pay off.

Next we will cover a topic that seems to pop up and I am not too sure there are exact answers.  A good friend wanted to discuss the topic and get my opinion.  He has built up a very successful manufacturing business through the years. Now, a publicly traded company has interest in buying the company.  Today, these transactions normally involve some cash, and the balance of the buyout using the purchasing company’s issued or authorized stock.  Right off the bat you normally are going to be apart on value of the company.  Besides having outside third party appraisals, you may also have differing accounting practices that can make a huge difference in valuations.  Most selling companies will have an agreement that they will shrink  inventory to a specified amount prior to sale date.

I am going to talk in generalities as I am dated in these areas.  It has been 25 years since I was ensconced in law and corporate finance in regard to these matters.  Accounting laws change weekly, and good CPA’s get updates.  We have covered this in prior blogs but again will mention that we have standards in the accounting and financial industry.  These are established today by the Financial Accounting Standards Board (FASB) and, in turn use abbreviated descriptions such as GAAP (General Accepted Accounting Principles) or GAPP  (General Accounting Principles and Practices).

Getting back to this larger company which has an interest in purchasing my friend’s company. Normally a large company under the scrutiny of filings with the National Association of Security Dealers (NASD) has a top accounting firm following accounting practices carefully.  Smaller private companies normally do not want to pay the premium price for one of these big accounting firms, and may differ to some degree on balance sheets and income statements.

As we look at this, immediately one of the differences in value may be real estate owned and value of machines/equipment and materials. Depreciation schedules may be different. My friend honed in on one area of differing value I want to cover now.  At what point do you transfer assets on the balance sheet over to the income statement (let’s say into sales column), and at what point and to what percentage do you take liabilities off the balance sheet and expense them on the income statement?

Here is where the standardizations come into play, and it can vary with industry. With my friend’s company they take a certain date, let’s say month end or year end, and fix a percentage to the goods/materials in production.  That isn’t too tricky, but how about labor costs?  On a balance sheet goods would go down as an asset, but salaries and contractor costs need to go into this equation.  Of course, once an item has been completed, providing payment it can be placed in the income statement and cost of goods sold and labor costs go down as an expensed item. Then, you also look at has the item been paid for, receivables and for how many days, net how many days, or uncollectible accounts.

I have been related to the real estate development and building business in some capacity since 1970.  We have the same issues, especially in home building.  Every home-builder pushes like crazy to finish homes and sell them prior to fiscal or calendar year ends.  Get the homes off the balance sheet including carrying costs on the liability side, and into the income statement as sold homes as soon as possible.  More pressure is to bear if it is a publicly traded company dealing with Wall Street.

Bottom line, hire a good accounting firm that understands your industry and the accounting standards that go with it.