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Let's Do Some Firing | The HBS Blog |
By Matt Cholerton Wednesday, January 18, 2012

Do you have an employee that just does not contribute? Do you ever wonder what the heck is this person doing here? Do you get negative feedback from employees or customers? You muse, ‘they have only been there a few months’ so we should give ‘em a shot. Or you think you can’t get rid of them because ‘they’ve been here forever’!?

Well, it’s time. Go on. Don’t wait to fire any longer. Just. Do. It.

But...but...wait you say? You have a small team and you worry about the impact on morale? Well, the negative impact on morale builds everyday this under performer is still at the company. Imagine how hard it is to give it your all, when you the person you sit next to someone that sucks. There is very little that is more demotivating. Disruptive, negative, or under-performing employees set you back way more than just their direct lack of performance.  Poor performers are infectious! In the way they handle projects, talk about clients and the direction of the company, they can contaminate your momentum. Poor performers will stick around as long as they can. On the other hand, excellent performers will only stick around so long when they see you value them and don’t tolerate and foster less.

Falling behind in projects, damaging vendor relationships, and losing information are often fears much more than they are actual issues. You might be surprised to find no gaps, or an improvement, after an under-performer departs.

But...but...but you worry about the legal repercussions - “California law makes it so hard... “ or “We don’t have the right documentation in place.”  Blah blah.  As an HR person I know I’m not supposed to say that, but you are trying to run a business! And this is killing you. If you are a fair and non-discriminatory employer, acting according to the true business needs of your organization, you shouldn’t have anything to worry about*.

*A quick disclaimer: I am not a lawyer. I will not take responsibility for your employment decisions and I know every time you have to call a lawyer its prohibitively expensive. And yes, sometimes it is complicated. Everything you do as an employer involves some risk.

Let’s turn to Exhibit A: Jack Welch made a career out of firing the lowest performing 10% annually.  This was a formal system at GE, forcing a differentiation between the 20% of top performers, the 70% of adequate or average performers, and the 10% of under performers. The top tier was rewarded disproportionately. They were given money and generally lavished. The bottom 10% in Welch’s system had to go - no ‘if’s’, ‘ands’ or ‘buts.’  It was controversial, but it forced managers to make hard decisions, that they most likely would have never gotten around to otherwise. It set the tone of performance, expectations, and values. Some credit this system with a 28-fold increase in earnings and a 5 times revenue at General Electric in the 20 years of Jack Welch’s tenure.

Every company has its own culture. Most companies would say part of their culture includes a team of exceptional performers and investing in their team. Unfortunately, most companies, for all kinds of reasons, also allow under-performers, bad-apples, and legacy function to exist for way too long. This is a trait you need to break. Not only are relaying on folks that only do a sub-par job for you, but more importantly it’s a culture that demotivates your top performers.

Rip off that band-aid! You might find it the best thing you ever did.

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101: Income Statement Part I
By Gregg Schoenberg Tuesday, January 17, 2012

We recently wrapped up our two-part piece on balance sheets, and today we are going to move on and start taking a look at the next financial statement on our list, the income statement, also called a “profit and Loss Statement”.  Unlike the balance sheet, which looks at a company’s financial position at a specific moment in time, the income statement reflects performance during a period of time, typically a calendar year or quarter.  Let’s continue with our fictitious ABC Corporation and have a look at its income statement below.

ABC Corp. Income Statement Dec. 31, 2010

Total Revenue $150,000
Cost of Goods Sold (COGS) $60,000
Gross Profit  $90,000
Operating Expenses  
Research & Development (R&D) $5,000
Selling, General and Administrative Expenses (SG&A) $45,000
 Operating Income    
Earnings Before Interest & Taxes (EBIT) $40,000
Interest Expense $5,000
Taxes (30%) $12,000
Net Income $23,000

 

As with our sample balance sheet, your company’s income statement will not look exactly like this one (it may be missing some of our entries and contain some additional line items), but it should follow the same general pattern.  It will start with a figure labeled total revenue or perhaps net sales—which is essentially the same thing—at the top, and then break down various expenses before concluding with a net income (or loss) figure on the bottom line.  This is why people often refer to a company’s profitability as “the bottom line”.

Let’s go through ABC’s example line by line and see if we can start to get an understanding of some of the major items that you can except to see on an income statement.

Total Revenue (or Net Sales) – This is pretty straightforward; the figure represents the total amount of money that the business brought in for the period covered by the income statement. If the company has any other income streams, they will also be listed, such as interest income, income from investments, or other income.

Cost of Goods Sold (COGS) – COGS tells us how much money we spent to acquire and produce the goods that we sold to generate the revenues included in the line above.

Gross Profit – Is equal to total revenue minus COGS.

The next section of our income statement breaks down a group of costs known as operating expenses, which include things like salaries, office supplies, and other items that are essential to the day-to-day functioning of a business.  If an expense can’t be included under COGS (i.e. it is not directly related to the production of a good or service) then it should appear as an operating expense.  ABC’s operating expenses are divided into the following two entries.

Research and Development (R&D) – These costs are often thought of as those that pertain to the future of a business, such as the testing and development of a new product or prototype.

Selling, General, and Administrative Expenses (SG&A) – This broad category encompasses all of a firm’s personnel costs (salary, benefits, and the like) as well as things like advertising and travel expenditures. Sometimes these and other like expenses are detailed out as separate line items.

We now move on to the operating income section of the income statement, which in our case contains these four items.

Earnings Before Interest & Taxes (EBIT) – This figure shows us a company’s total profit before accounting for interest and taxes that it has to pay.  Although this may not seem like a useful metric, and indeed there are many who argue that it is not, because everyone has to pay taxes and all borrowers must pay interest on their loans, some people find it helpful to isolate a company’s ability to generate profit and to compare similar companies with different tax rates and barrowing habits.

Interest Expense ­– The amount of money that a company pays as interest on its loans during the period covered by the income statement.

Taxes – We’re all familiar with this one, on the income statement the figure represents the total tax bill for the period and is sometimes expressed as a percentage (i.e. a tax rate) as well as a dollar figure. S-corporations, remember, do not pay taxes, but rather pass the tax liability through to the shareholders.

Net Income – Often referred to as a company’s “bottom line” because of its position on the income statement, net income is what is left over from total revenue after subtracting all expenses.

That brings us to the end of ABC’s statement and of this week’s post.  Next week we’ll dive deeper into how to analyze and interpret the income statement.

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Balance Sheets Part II | The HBS Blog |
By Gregg Schoenberg Wednesday, January 11, 2012
Assets Dec. 31, 2010   Liabilities & Equity Dec. 31, 2010
Cash

$12,000

  Accounts payable

$6,000

Accounts receivable

$13,000

  Notes payable

$4,000

Inventory

$10,000

  Accrued payroll

$8,000

Total current assets

$35,000

  Total current liabilities

$18,000

      Long-term debt

$20,000

Fixed assets

$15,000

  Total liabilities

$38,000

      Common stock

$10,000

      Retained earnings

$2,000

      Total common equity

$12,000

Total assets

$50,000

  Total liabilities and equity

$50,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In our previous HBS entry, we introduced readers to the balance sheet of the fictitious ABC Corporation presented above.  At the time, we gave a brief explanation of each of the items on the balance sheet that you may want to review before diving into this post, which is aimed at informing you how to “read” a balance sheet for information on the financial condition of a business.

Before we get into the nitty-gritty of balance sheet analysis let’s revisit something we raised at the end of our prior post: the fact that for all businesses total assets are equal to total liabilities plus equity.  Now that you know what is meant by assets, liabilities, and equity, this equation should make intuitive sense.  If ABC Corp. were to sell off all of its assets it would receive $50,000; if ABC pays off all of its liabilities it will have to shell out $38,000 leaving it with $12,000, which is equal to the company’s total common equity.  Thus we see that assets minus liabilities equal common equity, and some simple math then tells us that total assets are equal to total liabilities plus equity. Common equity is what is left when liabilities are subtracted from assets and is therefore sometimes referred to as the net worth of a company.

So what exactly can a balance sheet tell a small-business owner?  It can help you to gauge the financial health of your company and to analyze trends that may be occurring over time.  It is also one of the cornerstones of financial reporting that lenders and investors will want to analyze before deciding whether or not to provide funding to your business.

One very important figure we can calculate is the current ratio, which is equal to current assets divided by current liabilities; in our example $35,000/$18,000 equals a current ratio of 1.94.  Because the current ratio measures a company’s ability to pay its short-term liabilities, it is a favorite of banks and other lenders. While current ratios will vary from industry to industry, a rule of thumb for small businesses is that lenders like to see a current ratio of at least 2.0.

Because inventory typically represents the least liquid of a firm’s current assts, we also want to gauge short-term financial health without relying on converting inventory into cash.  We accomplish this by looking at the quick ratio, which is equal to current assets minus inventories, divided by current liabilities. A company’s quick ratio (in our case ($35,000-$10,000)/$18,000 = 1.39) will obviously be lower than its current ratio but it will hopefully be greater than 1.0, meaning that it can pay off its current liabilities without having to worry about selling its inventory.

Because it represents a picture of a company’s financial situation at a specific moment in time, a single balance sheet is not useful for analyzing trends.  In order to do this though, we simply have to look at two or more balance sheets and see how things have changed over time.  For example, are your inventories growing much faster than your revenues?  If so, this may be a sign that you are stockpiling too much product at the expense of more liquid assets like cash.

You’ll also want to keep a close eye on how your receivables change over time.  If they are increasing faster than your revenues, then you may need to improve your collections process and take a realistic look at who owes you money and how likely they are to pay it back.  If you find that you have one or two problem customers, it may be time to have a talk with them.

Hopefully you now have an idea of what your company’s balance sheet is all about and how to read if for clues as to the health of your finances.  While our discussion has been by no means comprehensive, it should have left you with an understanding of some of the most important information that a balance sheet contains.  For even more detailed analysis, a college or MBA level financial management textbook can be a great resource.

 

 

 

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101: Balance Sheets Part I | The HBS Blog
By Gregg Schoenberg Tuesday, January 10, 2012

With this blog we are going to begin a multi-part series in which we explore, explain, and hopefully enlighten our readers about the often-confusing world of financial statements.  We’ll be looking at the three most common statements—the balance sheet, the income statement, and the statement of cash flows—and trying to give you an understanding of how to interpret them and what they are telling you about your business.

Let’s start with the balance sheet, which presents a snapshot of a company’s financial position at a specific moment in time, often on the last day of the month, the quarter or the year.  The left side of the balance sheet lists a company’s assets (i.e. the things that it owns). The right side lists the liabilities and equity, which represent the financial obligations that the company has to others.  Assets are listed in order of liquidity, or the length of time that it takes to convert them into cash, and liabilities are listed in the order in which they must be paid.

Now let’s take a look at this sample balance sheet from the fictitious ABC Corporation and break down each of the items in a little more detail.

 

Assets Dec. 31, 2010   Liabilities & Equity Dec. 31, 2010
Cash

$12,000

  Accounts payable

$6,000

Accounts receivable

$13,000

  Notes payable

$4,000

Inventory

$10,000

  Accrued payroll

$8,000

Total current assets

$35,000

  Total current liabilities

$18,000

      Long-term debt

$20,000

Fixed assets

$15,000

  Total liabilities

$38,000

      Common stock

$10,000

      Retained earnings

$2,000

      Total common equity

$12,000

Total assets

$50,000

  Total liabilities and equity

$50,000

 

We’ll begin with the asset side before moving on to liabilities and equity.

Cash – This one is pretty easy.  In addition to actual bank notes, cash also includes any money that is immediately available, such as funds in a checking account.  Cash is, by definition, the most liquid of all assets.

Accounts receivable – This represents money that is owed to ABC Corp. by its customers.

Inventory – Inventory is the value of the goods that ABC has in its possession but has not yet sold.

Total current assets – Are all assets that can be easily converted into cash within a year.  In ABC’s case its total current assets are the sum of its cash, accounts receivable, and inventory.

Fixed Assets – Fixed assets include things such as buildings, machinery, and office equipment which are necessary to run the business but which are not expected to be converted into cash.

Total Assets – Equals the sum of all of the assets of ABC Corp., in this case the figure adds up to $50,000 and is comprised of $35,000 in current, or short-term, assets and $15,000 in fixed, or long-term assets.

On the right side of the balance sheet we see the following items:

Accounts payable – The opposite of accounts receivable, this figure represents the money that ABC owes to suppliers, vendors, and other creditors that is due within a year.

Notes payable – Are loans that must be repaid within a year.

Accrued payroll – Is money that is owed to employees. Because ABC, like most companies, does not pay its employees daily it will accrue this liability to its employees between paydays.

Total current liabilities – All liabilities that must be paid within a year, in ABC’s case accounts payable, notes payable, and accrued payroll.

Long-term debt – Is any financial obligation of ABC’s that is due more than one year from the date the balance sheet was prepared.

Total liabilities – Equals total current liabilities plus long-term debt.

Common stock – Represents the value of the stock that has been issued to investors in ABC Corp.

Retained earnings – Are the earnings of ABC that have been reinvested into the business.

Total common equity – Also known as owners’ equity or stockholders’ equity, this figure is the sum of the value of the common stock plus retained earnings.

Total liabilities and equity – Comprises all of the money that ABC owes to others, plus the value of its common stock and retained earnings, in this case $50,000.

While the precise line items on a balance sheet will differ from company to company, the format that we have laid out here will not vary.  And while each company will, of course, have its own unique values for each entry on the balance sheet, one thing that holds true for ABC Corp. holds true for all companies: total assets are equal to total liabilities plus equity.  In our next post we’ll explain why this is so and start a more in-depth explanation of how to read and interpret a balance sheet.

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Baseball and Delaware Law Part II
By Michael Bell Monday, January 9, 2012

In my last article titled Baseball and Delaware Law we discussed the Los Angeles Dodgers and their owner Frank McCourt’s troubles. In this next article we discuss the latest developments between Major League Baseball and The Los Angeles Dodgers owner Frank McCourt.

On October 25, 2011 in an article on espn.com, “Major League Baseball claimed that the Dodgers owner Frank McCourt took nearly $190 million from the team in what a court filing termed “looting.”

In filings in Delaware Court, MLB said McCourt took $189.16 from the club -- $73 million in parking lot revenue through a separate company, $61.16 million to pay personal debts, and $55 million for personal distributions, the Los Angeles Times reported, citing documents.

MLB and Frank McCourt were headed toward a showdown in U.S. Bankruptcy Court in Delaware at the end of November. However, on November 1, 2011 espn.com reported that Frank McCourt and MLB reached an agreement to sell the Los Angeles Dodgers along with Dodger Stadium and the surrounding real estate. The decision not only brings to end a six-month legal battle with baseball commissioner Bud Selig, but, ends McCourt’s seven and one-half year ownership of the team.

McCourt ultimately realized that selling the Dodgers was in his best interest and that of the fans. As previously written in my first article Frank McCourt purchased the Los Angeles Dodgers in 2004 for $430 million. Based on various media reports from espn.com, the team is expected to sell for somewhere between $800 million and $1.2 billion this time.

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