If 75% of the value of your business in NOT reflected on your financial statements, how valid is the analysis that the accountant gave you?
After 30 years of being a CPA and preparing, reviewing, auditing, evaluating, analyzing and comparing financial statements, the sad truth is this:
TRADITIONAL FINANCIAL STATEMENTS CAN OFTEN MISLEAD YOU AND
THEY CAN TAKE YOU DOWN A DISASTROUS PATH.
The problem is that business owners often don’t realize the limitations. Even fewer of them know how to overcome the shortcomings of traditional financial statements. Below are the summarized and simplified financial information for two companies.
- Revenue (000s): Co A: $3,919 / Co B: $1,670
- Profit (000s): Co A: $25 / Co B: $25
- Shareholder Investment (000s): Co A: $685 / Co B: $507
- Annual Sales Growth: Co A: 54% / Co B: 7%
- Return on Investment: Co A: 3.6% / Co B: 4.9%
A SHORT QUIZ
Which company will be broke in 18 months?
A. Co A.
B. Co B.
C. Relying on only traditional financial information prepared using GAAP (generally accepted accounting principles) can often TOTALLY MISLEAD YOU about your company’s real performance.
The answer is C. In fact, the above example is real. Even though they had the same bottom lines, one company did fine and one went broke in less than 2 years. This happened even though the Z-Score (predictor of bankruptcy) did not predict the impending doom. The majority of your company’s value isn’t even reflected on your balance sheet. So how valid is the business analysis that the accountant gave you about how you are going?
“More than 75% of the average firm’s market value is derived from intangible assets that traditional financial metrics don’t capture… firms can’t manage what they can’t measure.” –Strategy Maps by Kaplan and Norton
So you can forget about what is on your balance sheet for now. The real value of your business is not reflected there. The most important asset your company possesses is its Customer Asset.
Customer Asset (CA) = Total lifetime value of all of your current customers.
If you were to sell your company, the buyer would perform an analysis of the true value of your business. This would be a detailed analysis of the CA. Isn’t it logical that you should have the same value focus as would a potential buyer? You need to know where the value is in your business. Once you have that knowledge, you can use it to improve the value of your business.
I see so many business owners who sell their business at X value, and if they had made a few strategic improvements to increase their CA, they could have received a 2 to 4+ times higher value for their business than they did receive.
There are hundreds of factors that can increase your CA. Many times they boil down to a few key factors. Even a small deterioration in a few important factors, when left unnoticed and unchecked, can accumulate into devastating profit results. Here is a simple example.
A retail outdoor sports store in the western US has 5,000 customers with these averages:
- Spend $90 per visit
- Purchase once per month
- Remain a customer for 5 years
- Profit margin of 35%
The average customer generates $432 per year. Over the customer life of 5 years it generates $2,160. The CA is $10,300,000. That sounds pretty good, right?
What if there is a problem brewing here that isn’t necessarily showing up in the financial statements? What if 12 months prior the CA was $12,300,000 AND, in the meantime, it spent $200,000 attempting to increase the CA? A huge problem may be in the works. Worse yet, the company might be in a situation like the quiz example above, and the fact that a serious problem is brewing is not evident from the traditional financial statements produced by their accountants.
Another Example: Let’s assume, for some significant reason, this client lost 15% of its customer base today. The impact of this event would reflect this way:
- The traditional accountant, using GAAP, would reflect this fact as: nothing has changed – no impact – everything is fine.
- The impact on CA, that moment, is: NEGATIVE $1.6 Million.
GAAP financials can be misleading. The CA analysis tells a truer story.
If that doesn’t scare you, it should.
Bottom Line: Your customers are your primary asset. The value of the asset can change quickly.
ACTION PLAN
Determine what your Customer Asset (CA) value was 6 to 12 months ago: How many active customers, how much do customers spend with you, how long do they remain a customer, and what is the profit margin?
Determine those same CA numbers as of today.
Determine how much you have spent on costs to build your customer base between the baseline and today. These are Strategic Costs (SC). They include such costs as advertising, salespeople, web-lead-generations, email marketing, direct mail, etc.
Compute how much your CA value went up (hopefully) divided by your SC you expended attempting to increase that value. What was your return on your marketing costs: CA / SC?
What are the significant factors that changed between the baseline and today? Look carefully at changes in these numbers:
- Total number of customers. Is customer attrition increasing or decreasing? Are lead generation methods working effectively to increase customer base? Are you losing customers to more innovative competitors? Do you have programs that alert you when customers appear to have abandoned you? Do you have a program to get them back as customers?
- Average annual sales per customer. Is it increasing or decreasing? Are salespeople trained in helping customers find additional products and services that will enhance the customer’s experience? Are they looking for logical extensions of additional products? If you sell hiking boots, are salespeople suggesting more comfortable inserts, cushy cocks, water repellent outer treatment, walking sticks, books on local hiking trails, gaiters to protect in snow, etc.? The list goes on.
- Profit margins. Are they increasing or decreasing? Are there systems in place to communicate with customers and monitor their changing tastes and preferences? Do you have systems to looks at trends in sales and margins?
If you want a system for improving the factors that impact your CA, see my article entitled Double Your Business Profits: While Your Competitors Struggle in a Challenging Economy.
OTHER RESOURCES
Google this excellent article: Gupta, Sunil, and Donald R. Lehmann. “Customers As Assets.” Journal of Interactive Marketing 17, no. 1 (winter 2003): 9-24. (Winner of Journal of Interactive Marketing. Best Paper Award.)
Available at Amazon.com: Strategy Maps: Converting Intangible Assets into Tangible Outcomes. By Robert S. Kaplan and David P. Norton. Harvard Business School Press.