MANUFACTURINGand DISTRIBUTION

PKfCertified Public AccountantsA Professional Corporation

2020 Camino del Rio North, Suite 500San Diego, CA 92108

Phone: 619-238-1040 FAX: 619-237-5177

SPRING 2010

LESSONS FOR A NEW ECONOMY

How to Work with the Bank

Access to credit is perhapsthe biggest challenge facingmanufacturers and distribu-

tors today. Left in a weakened stateby the recession, many have littleleft to attract lenders.

Their inventories are reduced andthey have foregone capital expen-ditures, using that cash to fundoperating losses and debt service."You've got to have money to makemoney," the old saying goes, butfinding it is more difficult than ever.

Yet somewhere out there, banksare lending. Certainly, they are beingmore cautious than ever, but mostbanks do have money to lend. So yes,there is money to be had by manufac-turers and distributors who positionthemselves correctly.

What's the secret to unlockingthe vault? As a potential borrower,it is important to understand whatbankers are looking for when makinglending decisions.

BE REALISTICConsider typical lines of credit. Mostare based on the idea that currentassets will be converted to cash withinthe next 12 months, and that cash willbe available for debt service. Realistically,a fair amount of that cash is reinvestedin new receivables and inventory. Sowith most lines of credit, whatborrowers perceive as a "short-term"loan is actually a permanentlyrevolving investment in current assets.

As long as the lender is willing torenew the line of credit every timeit matures, this works fine. But moreoften than not, that is not happeningin today's market.

Lesson: Be realistic about yourfinancing needs and be prepared tooffer a cogent repayment plan. Youmay be asked to take your line ofcredit to zero periodically, and thatwill require ready cash.

TELL THE WHOLE STORYBanks are lenders, not investors.At some point, they expect to bepaid back. Only cash repays loans,so banks are very interested in howa business generates and uses its cash.

Borrowers often believe that thehighest and best use of cash is asworking capital to grow the business.Lenders, burned by business ownerswho grew their businesses and theirlavish lifestyles, are now focused onunderstanding the borrower's totalfinancial picture, often referred to asglobal cash flow.

This means the bank wants notonly financial statements and taxreturns for the business, but compre-hensive financial information for allthe entities the borrower is involvedin. This includes personal financialstatements and tax returns, especiallyfor borrowers organized as S corpo-rations and LLCs.

Lesson: Be prepared to verify andvalidate income from all ownershipinterests. Show that you are willingto endure a little pain and sacrifice

by adjusting your personal lifestyle.Reduce lender frustration by havingcurrent financial information avail-able and be prepared to presentfinancial data even if you havenot filed your tax return or areon extension.

SHOW A RECOVERY PLANToday's loan will be paid withtomorrow's cash flow, so lenders areinterested in the company's future.For manufacturing and distributioncompanies, lenders want to see arealistic recovery plan, with solidprojections and their underlying

Employee Fraud:Prevention Starts with You

A Down EconomyCreates Gifting Opportunities

Employee Fraud: Is Someone Stealing from You?

According to the Associationof Certified Fraud Examiners(ACFE), American businesses

lose 7 percent of their revenues tofraud each year. While the medianfraud loss across all industries isapproximately $175,000 per year,it's even worse in manufacturing,where the median annual loss is$441,000.

No company can afford that. So,what can the owner of a manufac-turing or distribution business doto protect the company from suchdevastating losses?

The first step is to learn moreabout occupational fraud and how itis perpetrated.

Fraudsters often give clues to theirfraudulent behavior. For example,they are often experiencing personalfinancial troubles at the time of thefraud, or are clearly living beyondtheir means. In nearly two-thirds ofcases, they act alone.

"Asset misappropriation" topsthe list of types of occupationalfraud. This broad category includessuch schemes as billing and payrollfraud, check tampering and inven-tory theft. Unfortunately, manyof these schemes are ongoing, notone-time incidents. Check tamperingand fraudulent financial statementschemes typically go on for as longas 30 months before detection.

A LOOK AT THE PERPSThe ACFE's Report to the Nationnotes that fraud perpetrators usuallywork in the accounting departmentor upper management. Accountingpersonnel most often are involvedin check tampering schemes, whileexecutives are more likely guilty ofcorruption or financial statementfraud. The higher up they are, themore expensive the fraud.

STOP, THIEF!Fraud prevention experts suggestthese steps to reduce the likelihoodof fraud:

Zero tolerance. Integrity starts atthe top. When the boss follows thepolicies and procedures, it sets agreat example for employees to dothe same. This means that ownersand managers can't "borrow" money

from petty cash, give themselves aquick loan to cover personal items, orfudge their expense reports. If execu-tives are loose with company money,employees may feel that they can beloose, too.

Internal controls. According to theACFE, a lack of internal controls wasthe most commonly cited factor thatallowed fraud to occur. One easyway to diminish the opportunityfor fraud is to improve the segrega-tion of employee duties. Be surethat one person isn't in charge ofaccepting, recording and handlingboth incoming and outgoing monies.Separate the initiation and approvalof payments.

Also, shake up responsibilitiesperiodically, and insist that allemployees take their allottedvacations. Sometimes people whoexhibit excessive ownership andaccountability in their jobs areactually trying to hide something.

Employee education. Interestingly,nearly half of all fraud cases arediscovered via a tip or complaintfrom an employee, vendor orcustomer. Creating an open-doorpolicy and an anonymous way toreport suspicious activity can goa long way toward uncoveringfraudulent behavior.

Reinforce the idea that fraud hurtseveryone in the company. It causesnot only financial damage, but alsodamage to company morale andproductivity. It's important to beproactive about fraud prevention.Conduct surprise audits periodically,and talk about fraud detection anddeterrence openly.

Bottom line: Don't lose whatyou have worked so hard to build.Consider taking steps like thosedescribed here to help prevent fraudat your company. .:.

Please contact our firm to discussfraud prevention and internalcontrols.

Recession May Make Gifting Timely

Many manufacturing anddistribution companies havetaken a hit over the past

few years. In many cases, marketsare down, profits are down andvalues are depressed.

But this bad news may actuallybe good news for some manufac-turers and distributors when itcomes to their estate and giftplanning. Lower business valuemeans lower stock value, whichcan have positive implications forgift and estate tax purposes.

Say ABC Company was worth$10 million three years ago and istoday only worth $6 million. Its1,000 shares of stock were previouslyworth $10,000 a share, but are nowworth only $6,000 a share. By giftingthe stock at a lower value, the owner can:

• Give away more of the company'sstock per year and still take advan-tage of the annual gift exclusionof $13,000. This amount can bedoubled if both the owner and hisor her spouse use their annual giftexclusions.

• Transfer a greater percentage ofthe company's value faster, whichcan significantly reduce the valueof the owner's estate and there-fore reduce his or her estate taxburden. While the estate tax isgone in 2010, it's due to comeback in 2011 at a whopping 55percent, so reducing the estatenow can mean big savings foryour beneficiaries.

• Take advantage of estate and gifttax valuation discounts for stock inclosely held companies (minoritydiscounts and lack of marketabilitydiscounts) while still maintainingcontrol of the company. Notethat there is legislation currentlyproposed in Congress that wouldseverely limit or disallow thesediscounts, so gifting sooner ratherthan later may be wise. If theeconomy recovers and the value

of the company goes up, the ownerhas essentially given away stock ata bargain value, with substantialtax benefits.

HOW TO DO IT RIGHTThe first step in gifting companystock is having a frank discussionwith a trusted advisor. He or shecan help you decide whether a gift isappropriate for family members, andif so, when the gift should be givenand at what level.

Another consideration is whichfamily members should receive giftsof company stock. It may make senseto give shares to children working inthe company, but not to children whoare not involved. A CPA can helpfigure out gifting alternatives thatmake sense.

In addition, a valuation of thecompany must be done for giftingpurposes. Be sure to work with avaluation professional who is familiarwith manufacturing and distributioncompanies and knows about IRS giftand estate valuation requirements.

The professional must be prop-erly credentialed and able to defendthe valuation conclusion based onexperience and expertise. Have your

All gift and estate planningmust be done with long-

term goals in mind

valuation done at the end of 2010and consider making simultaneousgifts - one on December 31 and oneon January 1- to take advantage oftwo years of exemptions._ Finally, recognize that all gift

and estate planning must be donewith long-term goals in mind. Thestrategy may take years to imple-ment, but there's no time like thepresent to get started. .:.

Interested in a gift and estate taxstrategy involving company stock?We'll be happy to help.

How to Work with the Bank

assumptions. They want to know that you have a viable core business and avalue proposition that distinguishes you from your competitors.

Let them know how you will cover any losses you're incurring now.What changes are you making in management or other areas to position thecompany for success? How are you planning to support the company's needfor new equipment and other major capital investments?

Lesson: Be ready to show why and how your sales and receivables willgrow and how you plan to finance the growth. Prepare to demonstrate anongoing ability to keep debt service current and to reduce future financingneeds by managing inventory, receivables and fixed costs.

Before approaching lenders, work with your financial advisors to preparethe documentation you'll need for fruitful discussions with bankers.

Having a sound value proposition, realistic financing expectations anda workable recovery plan may convince them that you are worthy of theirattention - and their financing. .:.

Our firm can help you think through your financing needs. Please contactus to set up a time when we can discuss next steps.

sources aroundthe world. We WOT. publicly andprivately owned buslgesses, business

owners and decisio!l:tnakers. PKF-provides clients wf g;;. __ director leadapproach, givin ~ __.:pt; efficient,

comprehens' ,-.,,;= Ilport.

www;pkfs~iiqiego.com:.:=:=::i,;:;'

Revaluing Property Under IFRS

As adoption of InternationalFinancial Reporting Standards(IFRS) continues to move

forward around the world, compa-nies are becoming more aware ofthe differences between interna-tional accounting standards andgenerally accepted accountingprinciples (GAAP) used in the U.S.

One of the significant differences -and one that generally favors manu-facturers and distributors - is theability to revalue property, plant andequipment (PPE) at fair value underIFRS. The revaluation option allowsan entity with a significant amount ofunreported appreciation in its landand buildings to strengthen itsbalance sheet overnight.

ONE TIME ONLYThe revaluation option is onlyavailable once, upon initial adop-tion of IFRS. Subsequent to initialadoption, the company reportsPPE under either a cost model ora revaluation model.

The cost model uses historical costless accumulated depreciation, similarto GAAP. The revaluation modelallows entire classes of assets (such asland, buildings, machinery, vehicles,furniture, fixtures and office equip-ment) to be revalued at fair value.

If the company chooses the revalu-ation model, IFRS requires that itcontinue to do so "... with sufficientregularity to ensure that the carryingamount does not differ materially

from that which would be determinedusing fair value at the balance sheetdate." Typically, businesses performrevaluations every three years.

Revaluation allows a company topresent a more realistic picture of itsassets. For example, if a companyacquired its land and buildings 30years ago, that property has beenaccounted for under GAAP at histor-ical cost and is therefore likely to beundervalued.

In the end, revaluing PPE at fairvalue presents a more current, andperhaps more attractive, picture tobanks and other third parties. .:.

Interested in learning more? We willbe glad to discuss IFRS with you.

This publication is distributed with the understanding that the author, publisher and distributor are not rendering legal, accounting, tax orother professional advice or opinions on specific facts or matters and, accordingly, assume no liability whatsoever in connection with itsuse. The information in this publication is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of(i) avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions or(ii) promoting, marketing or recommending to another party any transaction or matter addressed in this publication. © 2010