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“One in five U.S. homeowners with mortgages owe more to their lenders than their properties are worth, and the rate will increase as housing values drop in states that have so far avoided the worst of the crisis, a new study shows.

About 8.31 million properties had negative equity at the end of 2008, up 9 percent from 7.63 million at the end of September, according to the study, released Wednesday by First American CoreLogic. The percentage of “underwater” borrowers rose to 20 percent from 18 percent.

Another 2.16 million properties could go underwater if home prices fall another 5 percent, the study shows.” (Link to Reuters Article)

Commentary:

This is a leading indicator for how deep the banking crisis will get. With so many people underwater in their mortgages, the banks essentially own the homes and are relying on the homeowner to continue making payments. Many homeowners are throwing in the towel, pitching their keys onto the living room floor and walking away. Housing prices got way out of control in the last 7 years in many of these markets. There is still a lot of air to be taken out of home prices. This thing could get much worse before it gets better. –Allen

Before I came back to Little Rock, I worked for Intel Capital, the world’s largest corporate venture organization. I was a member of Intel’s core mergers and acquisitions team as the valuation specialist and worked on a total of $4B worth of deals that went up to the Board of Directors level or beyond.

Intel had developed very effective methods for valuing, structuring and managing their acquisitions based on the McKinsey approach to valuation.

CFO has adapted a similar process for evaluating and managing acquisitions for its clients that we feel is extremely powerful.

In essence the methodology involves establishing the value drivers of the deal, basically those things that were critical determinants of why you were doing the deal, what you were paying for and what you had to accomplish with the combined entity after the deal was done.

We build up a valuation model before the deal is done around those value drivers to help you get comfortable with the cost of the deal (which would include operating losses going forward). The idea of course is to quantify the value of the deal vs. the cost.

This methodology might also suggest more effective ways to structure the deal to enhance value or minimize risk of value destruction. For example, you may install performance payouts over time to the key employees aligned with the value drivers.

Going forward the same model used to value and structure the deal is used to become the operating model (and budget). This assures that you have a seamless process for value creation and harvesting.

As you likely know, more than 50% of acquisitions are subsequently determined to be failures. This inefficiency is due to errors in estimating the value of the deal, structuring the deal and most importantly with integration of the deal.

In short, with CFO Network you’d have a powerful partner on board who could seamlessly help you develop your acquisition capability as a core competency… even a secret weapon.

–Allen

What are the odds of a recession coming? Don’t ask an economist. President Harry S. Truman once said he wanted a one-handed economist because all of his economic advisers kept giving him advice saying, “On the one hand, this…And on the other hand, that…”

The reality is that no one really knows with certainty that a recession is coming, how bad it may be and how long it may last. Some even say one has already begun and we don’t even know it yet. I once met the captain of one of the largest crude oil tanker ships in the world. He told me these ships are so massive that it takes days to get up to full speed. Once a tanker is at full speed it has so much forward momentum that it could be on a collision course with another tanker before it can even see other one over the horizon. Just imagine, you could throw the wheel all the way to starboard, put the engines in full reverse with nothing on the horizon and it is still too late to avoid a crash. “That’s why,” he said, “you need good instrumentation.”

Unfortunately, some businesses are the same way in reacting to a looming recession. They are headed for disaster and they don’t take evasive maneuvers in time. They lack the visibility and the flexibility to respond quickly enough. Here are some important things you can do to survive a recession.

First, you must get greater visibility into your business so you can react in time and make the right moves. What does this mean?

Get better visibility into your customers. You are staying in touch with your customers? Are they struggling? Are their needs changing? Do you know who your most profitable customers are?

Get better visibility into what you are doing that is of value to others. Is the mix of products and services sold changing? Are you offering the right products or services? What are your individual margins on the products and services they are consuming?

Get better visibility into your costs. Do you have accurate, timely and relevant visibility into your true costs? How do your costs change with changes in sales? Is it time to attack wasteful spending? Do you need to shift your costs to a more variable structure? If you need to cut, do you know what to cut and when?

Do you have the capability to put it all together and see how all these variables interact? If revenues decline by 25%, what will happen to your cost structure? Your cash flow? Your balance sheet? What will you do in response?

Second, be prepared to act quickly and decisively once “reality happens”. Stunningly, even businesses that eventually figure out the right moves will still die because they failed to act until it was too late.

Is a major cost reduction required? Unfortunately this usually means people have to lose their jobs. I’ve seen business owners refuse to lay off one employee until eventually the entire business fails and all of the employees end up losing their jobs. Business owners must understand that the business must stay healthy for the good of the whole. Do you do regular employee performance reviews and know the people you need to keep and the ones who need to go? Is a new compensation system needed? What are the revenue impacts? One tradeoff with a major cost reduction is that it usually limits the overall capacity of the business to handle sales. If the economy quickly recovers the business can be left with an inability to handle the new business, leaving money on the table. Does a reduction create a bottleneck? Take time to review the operational theory of constraints and look for a balanced capacity across all areas of the business.

Finally, what changes to your balance sheet are required? Do you need to raise cash by whittling down your inventory or focusing on collecting receivables? Do you have an appropriate mix of debt and equity? Do you have the right assets and the right financial flexibility? With a strong balance sheet you can look for opportunity. You may be able to pick up additional equipment or acquire a competitor at an attractive price and be in position to reach new heights after the storm passes. The time to start preparing is now.

Allen Engstrom is Managing Partner of CFO Network, a provider of outsourced accounting and financial consulting services to businesses locally and nationwide.

Business planning is one of those “nice to have” things for executives. Most say business planning is a good thing, but yet only a small percentage report doing it on a regular basis, especially executives in small and medium businesses. If business planning is done well it can be a worthwhile investment and can actually help prevent the fires from popping up in the first place. The trick is to learn from those that do it well, adapt it for your own organization and integrate it into the fabric of how you run the business.

I spent 14 years working in the areas of strategy, investments and finance for companies such as Motorola Semiconductor and Intel Corporation. Intel in particular is renowned for its planning and execution capability. The semiconductor business can be lucrative to the winners, but brutally competitive and severely punishing to companies that make mistakes.

It is an industry where a company has to spend over $2 billion on a factory today and correctly guess right quantity and mix of products two years from now. Constant changes in demand for new products are extreme, but also is the continuing obsolescence of the manufacturing technology. New product design can cost hundreds of millions and if one of the 40 million transistors is wrong, you go back to the drawing board and lose your manufacturing window. Billions down the drain.

Needless to say, one of the secrets to Intel’s rise to one of the world’s most respected companies was that it developed a very powerful process for business planning early on, invested in it and made it a core competency.

Soon after I joined Intel in the late 90s the Asian Currency Crisis hit. One by one Asian economies crashed and a global recession was forecast. In response Intel slashed spending on manufacturing capacity.
It was the wrong move. The global economy quickly recovered and the dot-com boom kicked into high gear. Global demand for semiconductors skyrocketed and Intel was without critical capacity to fulfill demand. The company left untold billions of dollars in profits on the table.

By early 2000 there were signs that the dot-com bubble was bursting but Intel was determined to not let the same mistake happen again. It maintained a strong pace of investment in manufacturing capacity and got burned the other way. Demand fell off a cliff, inventory began piling up and factory lines were running at a fraction of their normal capacity. Intel’s margins plummeted, a lot of people lost their jobs and hundreds of billions of dollars in market capitalization was vaporized.

The point is not that one should have correctly predicted the Asian Currency Crisis or the Dot-Com Bubble, but rather that planning done well is a critical learning process and can be an extremely valuable tool to respond to change.

With strategic planning done well, one has participation from all the stakeholders from lower management to the top. It is everyone’s plan and so everyone takes ownership. Second, the process itself is an engine for making nimble changes in direction. Developing the tools, processes and management experience to effectively respond to change can pay huge dividends. In Intel’s case it could be argued that the impacts would have been much worse if it were not able to recognize the problem, evaluate corrective action, align everyone together and execute on the new plan as rapidly as it did. Third, because it is woven into the regular course of business and helps minimize firefighting, it is a minimum of cost and distraction. Finally is the learning element. Intel gets a great deal of value by going back and reviewing the plan and evaluating it against reality. This is of incredible educational value to business managers that cannot be taught any other way. A business planning process designed with these capabilities in mind is an outline for how it can be done to yield a positive return on investment.

Allen Engstrom is Managing Partner of CFO Network (www.cfonet.biz), a North Little Rock based provider of outsourced accounting and financial consulting services

Getting the bills paid on a weekly basis.
CFO places a sheet fed scanner on site with our client enabling “scan-to-email” capability. Our client simply gathers the bills and sends them to us with the touch of a button. Within hours the client logs into the accounting system via remote desktop technology and is able to verify that the bills have been entered and referenced. There is a question about one of the bills. Our client simply notes the reference number and within thirty seconds is able to pull up the source document image stored on our server to verify the amount entered is correct. CFO has already sent a report to the client outlining bills due, the vendor name, amount, balance, due date, etc. The bank has been balanced as of today, so the business owner is able to quickly verify that sufficient cash is in the bank to pay the bills as due. In less than 5 minutes the owner has marked up the report with instructions on what to pay and sends it back to CFO via email. This represents the approval to pay. Within eight hours checks are printed, signed with the owner’s signature stamp and in the mail. On a monthly basis, CFO reconciles each vendor’s balance to the accounts payable register.

Reviewing the financials on a monthly basis.
Each month at an appointed time CFO schedules a time to meet with our client to do a comprehensive review of the financial situation. This meeting is scheduled using CFO’s online collaboration tool. This enables the client to click on a link provided in Outlook’s calendar notice. Within seconds the client is looking at the same computer screen at CFO’s office. CFO is able to provide an audio conference number allowing people in multiple locations to join. For those local, CFO has a fully functional meeting room where we are able to project financials on a screen.