Conceiving and building a sound finance strategy involves working with the known and dealing with the unknown. Creating logical strategic initiatives in a stable business environment is a challenge in and of itself. The small and emerging

business owner, however, must be prepared to strategize in the midst of a changing world. The shifting business environment always presents situations that threaten the organization’s objectives. It is the job of the business owner to ensure that the finance strategy is prepared to deal with inherent threats and turn them into opportunities.

Any seasoned executive or business owner will agree that avoiding problems is better than dealing with them as they arise. This is the essence of strategic planning. Although it is impossible to identify all circumstances that the growing enterprise may encounter, it is important to identify those situations that may present the greatest hazards. If they are identified, the business owner sets the stage to diffuse circumstances before they become a true threat. Costly threats to the organization may arise from:

■ Going public

■ Regulatory requirements

■ Doing business in foreign countries

■ Litigation

■ Technology needs of vendors and customers

■ Employee needs

■ Strikes

■ Natural disasters

GOING PUBLIC

Private Companies

Many small and emerging businesses are private, closely held companies; that is, they have a small group of owners who represent neither institutions nor other individuals as owners. The owners themselves often are involved directly in operations. The business must remain focused on generating knowledge for the exclusive use of business owners to make decisions. The finance function may or may not be efficient in small privately held companies when it comes to ensuring that enough cash is being generated to keep the business going. The private environment lacks the distractions of nonoperational information needs (earnings and performance expectations by absentee owners [shareholders]), giving privately held companies the luxury of developing finance infrastructure in a less-frenetic environment.

Public Companies

Many small and emerging companies have sought and found financing in the equity markets. By participating in the equity markets and going public, they have availed themselves to adequate levels of capital to fund the business. Participating in the capital markets, however, comes with a price. Because a public company handles other people’s money, it is subject to the myriad of accounting, disclosure, and reporting rules dictated by the U.S. Securities and Exchange Commission (SEC). These rules require a heightened level of functionality and sophistication in the finance function. Without adequate preparation, a small or emerging business organization that goes public can fall prey to the swiftly moving dynamics of public disclosure. The fallout from a lack of vigilance in this area could manifest itself in the form of shrinking market capitalization (number of shares outstanding stock price) or a waning company image (brand). Both of these maladies could result in delisting (getting permanently or temporarily barred) from the exchange, paralyzing lawsuits from shareholders, or sanctions for company executives. The primary areas of risk for the small and emerging business seeking to go public lie in the nature of complying with disclosure rules which include employing generally accepted accounting principles (GAAP) (see next section), dealing with the shareholder/analyst community, and managing performance expectations of the public.

Public companies are required to adhere to the general framework of accounting guidelines, which are issued by the accounting profession and referred to as GAAP. To keep GAAP guidelines relevant, the profession constantly updates them and evolves this conceptual framework to keep pace with the business community. The reporting requirements are intended to lend a level of consistency to all financial statements issued by companies that are traded on the public exchanges. Depending on the industry and type of transactions engaged in, GAAP may be extremely complex or relatively straightforward. Regardless, management bears the burden of ensuring that the company is reporting its financial data in an accurate, GAAP format. Although professionals from the public accounting industry audit the financial statements of publicly traded companies to opine on the fairness of GAAP compliance, it is ultimately the responsibility of management to take reasonable steps to ensure consistency and accuracy in reporting. While it is easy to enlist professionals to help the business report the data generated by the organization, the real challenge is managing the changes to GAAP, in particular assessing the impact of the changes on the organization’s financial statements. This includes keeping tabs on rules issued by the profession as a part of GAAP and monitoring disclosure rules issued by the SEC.

Because legally mandated disclosure rules and financial statements are the bases by which absentee shareholders judge the health of the company, it is important for management to understand the impact of accounting and disclosure rules on the shareholder community. What are their expectations? How will changes in reporting the company’s financial results impact the stock price? When combined with the need to gather data to make general operational decisions, the ability to meet all federally mandated reporting requirements in a timely manner represents a formidable challenge for the finance function in small and emerging businesses.

Before exposing itself to these rigid reporting requirements, a company considering going public should assess its ability to gather, process, and analyze financial data with the dual objectives of reporting as disclosure rules require and creating knowledge for decision making. Any small and emerging business that has not examined itself for these capabilities is courting disaster. For example, disclosing worldwide data on the Form 10K (an annual filing with the SEC) on a geographically segmented basis as required by the SEC may be beyond the capability of an organization’s systems and processes. Not being equipped to gather and report the data this way is not an excuse to not disclose it. In this instance the company would be forced to estimate this activity breakout if it could not get it from its finance department. Incorporating estimates into the reporting process puts the company at risk of providing misleading financial information to the public, whether intentional or not. The result can be severe sanctions for executives including fines, removal from office, or even jail time. Having adequate systems and personnel to interpret standards and company data is crucial to existing in a public environment. In certain circumstances, companies in the public arena go overboard in developing data systems that are focused on meeting external reporting requirements to the exclusion of overall data needs. Keeping these two imperative needs in balance is a formidable challenge. Surprisingly, the data processing and analysis function in many public companies is much like the Maginot Line in its rigidity and one-sidedness. Built more toward complying with the public disclosure rules and statutory reporting requirements, these systems are focused on putting data into financial statement form as opposed to generating forward-looking knowledge. In this way, the lack of strategic thinking by business owners and management leaves many companies, large and small, with a data flow process that falls short of meeting the organization’s internal information challenges.

Shareholder/Analyst Community

The needs of the shareholder/analyst community are an aspect of the environment the organization will have to deal with if it has a presence in the equity markets. As stewards of the finance data, it is the responsibility of management to understand the needs of shareholders and serve them. The cornerstone of this responsibility is the delivery of accurate and timely financial statements to Wall Street, or the general public. The company will have to go beyond this, however, if it intends to maintain a healthy relationship with this community of data customers, especially if it exists in a high-profile industry. With management’s responsibilities traditionally focused on building and maintaining the finance organization for its own decision-making purposes, liaising with the Street may be beyond the scope of its abilities. Creating and managing reasonable expectations as well as adhering to fair disclosure laws in meeting shareholder needs are areas of responsibility that management must work into their strategy models.

Managing Expectations

A key component in dealing with the shareholder/analyst community for public companies is managing expectations. Maintaining a high stock price (and market capitalization) is a high priority if the plan is to use company stock to facilitate mergers and acquisitions, pay employees, or seek financing. With this in mind, the finance strategy should seek to manage this aspect of the business environment.
In the public arena, the company is evaluated from quarter to quarter. Depending on the industry or business sector, certain expectations may be thrust on the organization, including earnings growth, revenue growth, expense management, and acquisitions. Not being aware of these expectations could put management or the small business owner in the hot seat and put the company’s market capitalization at risk. Strong companies are skilled at setting expectations.
Setting expectations involves understanding the industry in which the business operates as well as what the business is capable of doing. From a finance perspective, it is worthwhile to know what contemporaries in the company’s peer group are doing. What financial multiples and ratios must be maintained? How robust must systems and processes be? Do peers make earnings each quarter? How do the stocks collectively perform? Are they in a volatile sector?

REGULATORY REQUIREMENTS

Complying with government regulatory requirements may present crippling consequences for organizations that are not prepared. Certain industries, from banking and insurance to mining and industrial chemicals, have a full slate of requirements dictated by state or federal governments that address certain aspects of doing business. As a result, some companies may be subject to costly regulatory requirements stemming from changing business circumstances, shifting laws, or unforeseen preexisting business conditions. Contaminated soil/property and pending product liability litigation are examples of circumstances that a business owner may have been oblivious to at one time and subsequently forced to deal with in quick order. The required response may tap out already thin cash reserves, devalue assets, alienate customers, and (worst of all) distract owners from operations. To determine if a company is prepared to deal with unforeseen regulatory issues, strategists should ask:

■ Do adequate cash reserves exist?

■ Is all the necessary insurance in place?

■ Have all foreseeable risks been identified?

■ Are owners in touch with industry peers regarding changing rules and regulations?

■ Does the company have quick access to legal counsel that knows enough about the industry to guide the enterprise through changing federal and local regulations?

From a financial standpoint, strategies should be in place that take into account unexpected regulatory barriers. Setting up adequate reserves and having the capability to quickly add the impact of new regulatory guidelines into budgets and forecasts may be the extent of a sound preventive finance strategy. If the organization is publicly traded, however, a process may have to be in place to communicate changes like these to the analyst community and shareholders in general, to manage expectations and optimize stock price. In this case the finance strategy may involve retaining an investor relations professional or firm to spin unexpected news and requirements to the public.

DOING BUSINESS IN FOREIGN COUNTRIES

The new economy (as dictated by the Internet boom) has created markets where
they previously did not exist while enhancing those that were once modest, at best. Companies in the United States are finding that penetrating markets in North America may not be enough to remain competitive with rival industry players. Burgeoning economies in Latin America, Asia/Pacific, and Europe are driving a changing world of market and cultural demographics. Before diving headlong into a foreign market, it is prudent to weigh the risks of participating in cross-border commerce with an upside potential.

The Internet

The chief driver of the new economy, undoubtedly, is the Internet. By providing cheap, (relatively) low-maintenance access to the global community, companies of all sizes and means can deliver products and services to once-inaccessible consumers. What is the cost of this unbridled access? Is the company exposed to local tax liabilities if it sells to customers in certain countries? What local disclosure rules are the company subject to? Is the enterprise violating trade treaties or laws by selling to the international community? Is the enterprise prepared to deal with local authorities in the case of trade or import levies? Could U.S. or foreign authorities force the enterprise to shut down its website or stop offering products and services? Any or a combination of these scenarios could have an impact on the financial health of the organization. What is the best way to strategize around such bumps in the road?

Brick-and-Mortar Operations

To better address the issues of doing business in foreign markets, it is best to examine the situation from a bricks-and-mortar perspective—that is, how would the enterprise function if it had a physical presence in a certain country? Having a physical presence in a country avails the company to advantages it would not have if it had no physical presence. Avoiding exorbitant tariffs and duties not to mention glacial import protocols are some of the major advantages of having a physical presence in a foreign country in which a company wishes to do business.
With these advantages, however, come the responsibilities to comply with local tax and reporting rules. Regardless of the company’s status (as a subsidiary, distributor, or manufacturing concern) in the foreign locale, foreign countries (with few exceptions) consider the company’s mere presence grounds to assess it as a legitimate tax-paying entity. This means allowing local authorities access to all books, records, and information systems for statutory review. It also means complying with all tax laws. Doing so could include definitions of revenue, expenses, assets and liabilities that differ from those of the United States. Lack of compliance with even the mildest of provisions could mean fines, penalties, or a cessation of business. Additionally, accounting treatments prescribed by foreign bodies, whether by the countries themselves, by administrative bodies like the International Accounting Standards Committee, or by a combination of both, must be understood and applied properly. In some cases, local GAAP rules and tax rules are one and the same; in other cases they may be different. Examples of countryspecific reporting rules are:

■ Thin capitalization rules. Many countries require that certain threshold ratios of debt to equity be maintained. For example, if Germany requires that all companies doing business within its borders have no more than a 1.5 to 1 debt-to-equity ratio, any slippage below this ratio could deem a company bankrupt and require it to be liquidated. Companies often must institute drastic measures in circumstances like this, such as injecting cash into the enterprise or converting debt to equity. The solution required to address such a problem may be counter to the company’s overall strategy.

■ Hyperinflationary accounting rules. Certain countries with unstable economies require the revaluation of balance sheet and/or profit and loss (P&L) balances on a periodic basis to mitigate the impact of a weak local currency. Economies that are hyperinflationary have specific rules for revaluing balances in an effort to keep year-to-year comparisons of data accurate. This may include creating and maintaining specifically defined accounts on the general ledger. In Mexico, for example, this is called the B-10 calculation and is mandated for all companies that are traded on the public exchange.

Aside from reporting and tax rules, a company must take into account cultural norms and the potential for political instability. Other countries may deal with issues related to social costs (equivalent to Social Security in the United States), vacation time, and employee hiring/firing very differently from what is done in the United States. Social costs may be significantly higher in foreign countries, something that must be factored into budgets and forecasts. The norm for vacation time in some countries may be a minimum of six weeks or more per employee. Rules related to constructive termination (where employees are deemed terminated due to a change in work environment) play a huge factor in some countries, especially if a restructuring effort is undertaken by the U.S. parent company. Generous statutory severance also plays a factor in restructuring efforts. These costs must be taken into account in budgets and financial models, whether they are one-time charges or recurring expenses, especially when the viability of operations is considered.
Infrastructure issues also play a role in doing business in foreign countries. The level of reliability of certain aspects of infrastructure vary wildly from country to country. The condition of roads, public structures, water supplies, phone lines, and electricity ranges from excellent to poor depending on the continent, country, or city. It is not uncommon in some countries for phone lines and power grids to go down for extended periods of time. If a period-end closing of the books relies on the submission of data from a country with poor or unreliable phone lines, the closing may be held up or put in jeopardy, a particular concern for public companies with scheduled press release dates and filing deadlines.

LITIGATION

Litigation can have a direct and/or indirect impact on the enterprise. The impact of litigation filters down to the bottom line in the form of fines, penalties, inability to sell a product, or mandated recalls. In a more subtle way, litigation impacts the way an entire industry approaches a market or an individual company’s brand image. A perfect example of both the overt and the subtle impact of litigation on the enterprise is embodied in the Microsoft antitrust litigation, United States of America v. Microsoft Corporation,5 which extended from May 1998 to April 2000 (original trial). The economic fallout from this action has already been borne by Microsoft shareholders. Microsoft’s market capitalization declined precipitously as the initial verdict was read and penalties proposed. The real and most far-reaching impact, however, will be felt by smaller, existing software makers and consumers. By mandating a change to the way Microsoft produces and markets its operating systems, the U.S. Justice Department can significantly alter the landscape of the computer software industry. The wide-open, hypercompetitive software industry sought by plaintiffs in the case may come to pass, which could change the financial fortunes for many.

Litigation also can have a direct impact on companies that do not follow reporting and disclosure rules. A good example is the case of Caterpillar Inc., a global manufacturer of heavy equipment. The company was subject to class action suits related to financial statements it issued in 1990. The lawsuits alleged, among other things, violations of certain provisions of the federal securities laws. The complaints alleged that company executives fraudulently issued public statements and reports during the period from January 19, 1990, to June 26, 1990, which were misleading in that they failed to disclose material adverse information relating to the company’s Brazilian operations, its factory modernization program, and its reorganization plan. In this case the lack of disclosure of potential foreign currency risk in its Brazilian operations led to shareholder lawsuits filed when the economy of Brazil hiccupped, adversely affecting the company’s financial statements. The precipitous drop in the price of the stock led to the lawsuits, which forced the resignation of key executives in the organization and led to other debilitating sanctions. The circumstances surrounding this case moved the SEC to issue specific guidance on disclosures in certain public filings.6 Acute punitive damages for ex
ecutives are becoming more common as the SEC continues to get tough with those who manipulate accounting and disclosure guidelines for their own benefit. This means jail time. Phar-Mor, Bennet Funding Group, Lumivision, Bernard Food Industries, and California Micro Devices are examples of companies whose executives served time for accounting/disclosure indiscretions.7

The key point is recognizing the need to evaluate risk in the organization. For the small and emerging business owner, this may be a challenge. The need to recognize the presence of risk in doing business and quantify it is the challenge of the finance organization. At the very least, reserves and insurance to cover potential litigation should be in place. However, as a growing business enterprise becomes more diverse in its offerings and the business environment becomes more complex, the finance organization must be suited to identifying and quantifying the risk associated with the direct or indirect impact of litigation.

TECHNOLOGY NEEDS OF VENDORS AND CUSTOMERS

The business owner must be in tune with suppliers and customers from an infrastructure perspective as well. The Internet has enabled business-to-business ordering, which greatly enhances the speed and accuracy with which orders for merchandise and services are communicated. This paperless model for handling customers and vendors, however, may require attention to system and application interfaces. Collaboration of the two is becoming more and more necessary for businesses with common supply interests or those that participate in similar vertical markets. Having adequate platforms and interfaces is a must to enable these tremendous cost-saving models.

Participating in these paperless models often opens up a whole new world of stewardship when it comes to systems maintenance. The intricate interdependencies of different companies and their interfaces or applications requires an allor-nothing participation commitment. If one component/participant goes down, how does this affect the rest of the consortium? How vulnerable to viruses or damage is the consortium? Can a single participant crash the whole system? Issues like these must be addressed up front before such an endeavor is sought as a cost-savings solution. Business owners must be willing to commit time and dollars to such solutions in an amount equal to that of other participants.

EMPLOYEE NEEDS

Some of the most challenging decisions made by small and emerging company owners relate to employee-related benefits. Health insurance, life insurance, and 401k plans may be a part of the business owner’s plan to retain top talent and foster loyalty. These plans have a cost, however, and the business owner has a responsibility to ensure they are appropriately funded and suit employees. Do these plans require a one-time outlay of cash to set up? How heavy will the funding obligations be over time? Will the funding obligations change over time? Is the company properly reserved to fund a huge liability to the program if needed? Employee benefit plans should be a part of any small and emerging business, but the business owner must be aware of the financial obligations of the particular programs that have been or will be put in place. The headache of switching programs for financial reasons may create confusion and bad will rather than peace of mind among employees.

STRIKES

Depending on the industry, labor strikes may impact the company either directly or indirectly. A company whose operations rely on organized labor (or other companies with organized labor) may be vulnerable in the event of a work stoppage. Work stoppages due to labor strikes could result in unfilled orders, slow returns, and supply chain slowdowns. For many small and emerging businesses, the impact of strikes may be more indirect. Merchandisers that rely on the Internet to reach customers may depend exclusively on the post office, UPS, or FedEx to deliver merchandise to customers. What type of provisions have been made to guard against the impact of strikes at courier companies? If a strike cuts off delivery to customers, how long could the company hold out? What is the run rate on cash? The company should have as a part of its strategy a finance model that addresses such a scenario.

NATURAL DISASTERS

All companies are subject to risk of some sort, not the least of which are acts of nature. Whether it is hurricanes in the Southeast, floods in the Midwest, or earthquakes in the far West, the most extreme circumstances must be considered when it comes to planning a business strategy. Provisions should be made not only for the operational aspects of the business in the event of a natural disaster (manufacturing, distribution, service support) but for the repository of financial data and the data flow dynamic as well. SEC filings, state and federal tax returns, debt compliance, and the like must be attended to regardless of circumstances. Although authorities make provisions for companies affected by such events, rarely if ever do they forgive a reporting requirement. In this age of electronic data storage, there is no excuse for losing all financial data and the capability to gather it in the event of a natural disaster.