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Brian Jacobson | Director 617-619-3376 [email protected]
FIELD EXAMINATIONS: REDUCING YOUR LENDING RISKS Fall 2019
Capstone Headwaters
Capstone Headwaters is the largest independently-owned middle marketinvestment bank in the United States and offers a full suite of Financial AdvisoryServices (FAS) including a leading Field Examination Practice led by Director BrianJacobson. As an essential part of a credit review, a field examination (field exam)allows Lending Institutions to objectively review an Asset Based Lending (ABL) orCommercial & Industrial (C&I) borrower’s collateral and financial strength toevaluate its ability to repay credit. With more than 25 years of experience in publicaccounting, auditing, and private company work, Jacobson‘s vast experience in fieldexaminations and loan reviews for financial institutions enables him to deliver high-level accounting and audit services to banks, finance companies, and other lendersseeking assurances of the collateral against which they are lending.
This report details Capstone Headwaters’ process for, and broad experience in, fieldexams, while also presenting the value of hiring an advisor with unique knowledgeof the nuances and niche procedures required for examining specific industries. Thefield exam procedures and scope can be tailored to specific needs.
FIELD EXAMINATIONS: REDUCING YOUR LENDING RISKS
TABLE OF CONTENTS Introduction Frequently Asked Questions Assessing the Borrower’s
Operating Cycle Testing Procedures by Industry Client Case Studies Firm Track Record Firm Suite of Offerings Report Contributors
INTRODUCTION
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Stages of a Field Examination(Full Scope Account Receivable & Inventory Exam)
• Tour facility and meet staff• Accounts Receivable test work
• Dilution / Invoice / Cash Payment• Inventory test work
• Costing / Physical Counts• Cash Tie Out• Internal Control Review• Wrap up outstanding items and prepare
outstanding items listing• Lender discussions on progress / issues
• Follow-up items and questions with Client’s customer
• Prepare field exam report
• Submit draft field exam to Client for discussion and comments
• Issue final report
• Prepare request lists and industry specific field exam questions
• Schedule on-site days• Begin data collection
from Client’s customer• Select substantive test
work samples for accounts receivable and inventory
Day 1 Day 2+
On SitePre On-Site Field
ExaminationPost On-Site Field
Examination
Source: Capstone Headwaters Research
Field Examinations | 2
An essential part of the field exam is an assessment of the borrower’s operating cycle, which reveals the length of timebetween the borrowers’ purchase of goods and services and receipt from accounts receivable. A careful assessment willprovide lenders insight into potential inefficiencies and errors. Generally, healthier companies have shorter operating cycleswhich leads to increased profitability.
Source: Capstone Headwaters Research
Borrower’s Operating Cycle
What is the Difference Between a Field Exam and a CPA Audit or Review?
A field exam is often used within ABL and C&I. Lenders typically understand that a field exam is not the same scope or testingas a Certified Public Accountants (CPA) audit or review, but on the business owner (borrower’s) side there is a commonmisconception that the CPA audit or review is the equivalent of a field exam. While the two may share similarities, they areactually distinctly different. Perhaps the easiest clarification is that the field exam is primarily focused on the collateral that thelender would use to satisfy the outstanding loan if the company defaulted on the loan agreement, while the CPA audit orreview is looking at asset and liability accounts at the borrower’s year end. During a field exam, procedures are performed onaccounts receivable and inventory both at a point of time for specific tests as well as activity that has occurred over a period oftime (generally at least 12 months).
What is the Focus of a Field Exam?
Each lending institution has its own criteria for having a field exam performed on a borrower. A commercial field examfocuses on the collateral as well as a business’ policies and procedures regarding the customers it sells to, its invoicing andcollection methodology and trends, its purchasing and payment patterns, how inventory is controlled and priced, theefficiency and timeliness of the books and records, and the overall cash flow of the business. Overall, components of theCompanies Operating Cycle and how they impact the lenders collateral are the focus of the field exam.
FREQUENTLY ASKED QUESTIONS
ASSESSING THE BORROWER’S OPERATING CYCLE
PURCHASES OF GOODS & SERVICESCASH
COLLECTIONHOLDING OR
MANUFACTURING INTERVAL
INVENTORYSALE
RECEIVABLES
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TESTING PROCEDURES BY INDUSTRYBy performing hundreds of field exams for almost every type of business, Capstone Headwaters’ Field Exam Practice hasdeveloped a detailed understanding of the unique review and testing procedures needed to accurately assess each industry.
While some aspects of exams are the same across all industries, many have unique characteristics or areas that need specificreview. A sampling of these characteristic and procedures is highlighted by industry below:
Source: Capstone Headwaters Research
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UNIQUE REVIEW & TESTING PROCEDURES BY INDUSTRY
Manufacturing
Pre-billing before shipment Rework products (credit & rebilling) Discounts, rebates, chargebacks Obsolescence for specialty made products Obsolescence for raw materials and
finished goods Job costing & bill of materials Customer right to return goods at the
end of the season
Services & Technology
Retail & Distribution
Inventory procedures Proper valuation of Inventory Obsolescence for style or season Shrink and Inventory adjustments Sales process & credit card
receivables Gift cards, vouchers, reward
programs Cash tie out and reconciliation
Construction
Customer & sales concentration Monthly recurring revenue Deferred revenue Customer churn Advanced deposits Service agreements Activity billing (milestones & objectives)
Work in progress schedule Profit fade Over and under billings and impact on
accounts receivable Retainage Bonded jobs Percentage of completion accounting -
uses budget estimates alongside costs incurred and costs to complete
CLIENT CASE STUDIESCompany: Packaging ManufacturerRisk Identified: Errors in the Gross MarginImpact to Institution: Improper Collateral Values & Decreased ProfitsSynopsis: The Company’s test results were initially satisfactory aside from several discrepancies inthe Gross Margin test which the Company was unable to adequately explain. Additionally, during theon-site visit, Capstone Headwaters (CSHW) observed a high-level of tension between the CEO andthe CFO of 30 years. Maintaining professional skepticism, CSHW discovered that the CFO hadstarted adjusting the costs and accounting after the lender funded the Company’s line of credit. Thisresulted in the Company reporting higher inventory values and weaker profits. CSHW’s analysisrevealed that the old costing methods needed to be revised for new cost pools and increased laborand overhead. As a result of the field exam, the manufacturer discovered that it needed to increaseits selling price on products to account for the new cost pools in order to maintain profitability.
Company: DistributorRisk Identified: Segregation of Duty issuesImpact to Institution: Internal control weaknessesSynopsis: Due to health issues, the Company’s owner had removed himself from the daily businessoperations and his children were only marginally involved in the Company. This left the Controller,who had been in place for more than 20 years, solely responsible for many operations including cashreceipts, cash disbursements, bank account reconciliations, and payroll. The Controller was also theonly person that could run reports on the Company’s outdated software systems. During the fieldexam, the Controller both delayed and resisted basic requests for information. CSHWs advised theCompany’s CPA to redistribute a number of duties to other employees to mitigate risks and improveinternal operations. The owner’s children subsequently took over several key processes, addinginternal checks and balances and minimizing the likelihood of fraud and error.
Company: PrinterRisk Identified: Identified Risk: Miscalculation of Credit BalancesImpact to Institution: Overstated Borrowing Base Certificate (BBC)Synopsis: During the field exam, CSHW discovered that a number of credit balances were incorrectlyincluded in the accounts receivable (A/R). The credit balances over 90 days totaled more than $2million and were not a reduction of eligible A/R on the Company prepared Borrowing BaseCertificate (BBC). In preparing the BBC the VP of Finance had added the positive balances under 90for the A/R rather than using the report totals. When this error was corrected, it caused a reductionin the available line of credit (LOC) and a consistent over-advance for the past several months.
Company: ManufacturerRisk Identified: Identified Risk: No Standard Purchasing ControlsImpact to Institution: Fraud that caused liquidity issueSynopsis: An interim review and a flux of the income statement and balance sheet at a family-owned business indicated that the Company would miss certain bank covenants at year end.However, when the draft results were published the Company did, in fact, meet its covenants bycapitalizing costs that had historically been expensed. As a result of CSHW’s field exam, theCompany management and CPA investigated the issues in detail and uncovered that a relative of theowner had purchased large amounts of goods without the standard purchasing controls includingpurchase order, approval, receiving documentation, and vendor setup. Without the oversight ofthese standard controls, the relative was able to create fictitious vendors and false expense reports todefraud the company of more than $1 million dollars.
Company: Seafood BrokerRisk Identified: Fraudulent InvoicesImpact to Institution: Collateral and Loan write off riskSynopsis: After the Company’s invoices consistently lacked adequate back-up for testing, theCompany’s credit lender hired CSHW to complete recurring field exams to find out more information.During the field exam, CSHW’s completed a substantive test as part of its standard performance onA/R and discovered that the Company had been creating fraudulent invoices. As a result of theexam, the bank liquidated the Company’s assets to pay off the remaining line of credit.
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FIRM TRACK RECORDCapstone Headwaters’ Field Examination Practice has completed exams including recurring field exams and pre-loan fieldexams for Financial institutions and Finance companies located all over North America. A sample of the types of Industriesinclude the following:
RETAIL & DISTRIBUTION
Auto PartsBath ProductsBathroom PartitionsBooks/CalendarsCommercial CamerasComputer EquipmentConstruction SuppliesElectrical SuppliesFlooringFood Products FootwearGraniteHardware/FastenersHigh Tech/VARHome ProductsIndustrial ProductsLightingLiquidatorLumberOffice FurniturePet ProductsPlumbing/HeatingPrinting Equipment & SuppliesScrap/Truck PartsSeafoodSporting GoodsWatches
MANUFACTURING
AsphaltBaked GoodsChemicalsCommercial Shipping CasesContract ManufacturingCustom SignageFire ProtectionFirearmsFood ProductsGas AnalyzersGas Containment EquipmentHigh Tech (Equipment, Sensors)Ice CreamIndustrial DyesLinen GoodsMachine ShopMedical DevicesMetal FabricationOutdoor FurniturePackaging ProductsPaint Personal CarePlastics PrintingRubber ProductsSeed PackagesSpecialty WeldingSteel Tubing /ComponentsTest Chambers
SERVICES & TECHNOLOGY
AppraisalAuto Accessory InstallsCall CenterConsultingConsumer SoftwareCrane/TrainingDisaster-Cleanup, ElectricalElectricalEnergy AuditsFood/CaféFoodservice ManagementGovernment Project StaffingHealth Care Claims ProcessingInsuranceInterior DesignMarketingMedical RecordsOil Delivery Outsourced AccountingPest ControlReal Estate ManagementRelocation ServicesSAS SoftwareService FulfillmentStaffing CompanySurvey/EngineeringTelecom ProviderTruckingWeb Services
CONSTRUCTION
BridgesDrywallElectricalFlooringFurniture/Furnishings
General ContractorHVACLandscape/ConstructionMarine Construction
MasonryMechanicalRoofingSignsTraffic Signal
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Capstone Headwaters' Financial Advisory Services group is utilized by private and public companies, private equity groups,business owners, managers, investors, and lenders. We specialize in enterprise-wide solutions aimed at performanceimprovement and increased shareholder value. Our services are tailored to clients’ specific needs and varying circumstances,such as those: working to grow profits and cash flows; navigating through difficult operating and financial environments;preparing for a merger or managing post-merger integration; addressing isolated business challenges; integrating systemsand resources across departments or divisions; and seeking to fill unforeseen management vacancies on an interim basis. Ourservices address performance improvement and value generation in all stages of the business life cycle.
MERGERS &ACQUISITIONS
PRIVATE PLACEMENTS
FINANCIAL ADVISORY
Sell-Side M&ABuy-Side M&A
Debt PlacementsEquity Placements
Corporate RestructuringPerformance Improvement
• Field Examinations
• Quality of Earnings Review
• Diligence Support
• Financial Management Effectiveness• Financial Reporting Practices• Operational Reporting & Metrics
• Debt Placement Services
• Market Intelligence
• Fairness Opinions
• Integration Consulting
• Synergy Realization
• Interim Management
• Interim CFO
• Interim Controller
• Field Examinations
• Financial Management
• Procurement & Contract Management
• Sales Management
• Turnaround Management
PRE-DEAL SERVICES
DEAL SERVICES
POST DEAL SERVICES
FINANCIAL ADVISORY SERVICES SUITE OF OFFERINGS
Capstone Headwaters has closed over 500 transactions totaling $24 billion in value.
• Nearly a quarter of revenues generated from cross-border deals.• Over 70% of M&A closings have been with strategic acquirers.• We have a rich history with over 3,000 private equity firms.• Initial valuations are exceeded 67% of the time.• We have achieved a 32% average valuation premium.• We have earned a 96% performance rating by our clients.
60%M&A
Advisory
88%PrivatelyOwned
BUILT FOR THE MIDDLE MARKET
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Brian JacobsonDirector [email protected] | 617-619-3376Brian is a Director with the Financial Advisory Services Team in the Field Examination Practice atCapstone Headwaters. As a Massachusetts Certified Public Accountant (CPA), Brian has more than25 years of experience in public accounting, auditing, and private company work and hasperformed field exams for a vast list of clients including Finance Companies and FinancialInstitutions. The entities that hire CSHW for field exams include Asset-Backed Lenders (ABL), CashFlow Lenders, and Commercial and Industrial (C&I) Lenders. The industries covered include alltypes of Distribution/Retail, Manufacturing, Service, and Construction clients. The purpose of thefield exams includes pre-loan reviews, ongoing collateral monitoring, and one-time reviews.
Prior to joining Capstone Headwaters, Brian worked at Gray, Gray & Gray, serving as Director ofField Examinations and Client Accounting Services. His vast experience in field examinations andloan reviews for financial institutions enables him to deliver high-level accounting and auditservices to banks, credit unions, and other lenders seeking assurances of the collateral againstwhich they are lending.
Prior to joining Gray, Gray & Gray, Brian was the Founder and Principle of ClearView FinancialServices, LLC, and served in senior financial positions for a wide range of companies, including D.Schumacher Landscaping Inc., AmeriVault Inc., Digital Broadband Communications, Inc., andStandard Electric Supply Company. Brian began his accounting career with Grant Thornton LLP’sBoston office.
Brian graduated from Bentley University with a Bachelor’s degree in Accountancy, and earned hisMBA at Boston College. He is a CPA in Massachusetts as well as a member of the MassachusettsSociety of Certified Public Accountants (MSCPA). Brian is also active in local community groups
REPORT CONTRIBUTOR
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EXTENDED TEAM
John Ferrara Founder & CEO
Jim CalandraManaging Director
Brian DaviesHead of Financial Advisory [email protected]
617-619-3328
Jacob VoorheesHead of Global M&A
Paul JansonCOO
Phil SeefriedPresident
Kent BrownHead of Debt Advisory
Daniel McBroomManaging Director
Brendan BurkeManaging Director
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www.capstoneheadwaters.com
Capstone Headwaters is an elite investment banking firm dedicated to serving the corporate finance needs of middle marketbusiness owners, investors and creditors. Capstone Headwaters provides merger & acquisition, private placement, corporaterestructuring and financial advisory services across 16 industry verticals to meet the life cycle needs of emerging enterprises.Headquartered in Boston, MA and Denver, CO, Capstone Headwaters has 19 offices in the US, UK and Brazil with a globalreach that includes over 450 professionals in 40 countries.
BUILT FOR THE MIDDLE MARKET
INTERNATIONAL450+ professionals
60+ offices in 40 countries
Asia: China India Japan Latin America: Argentina Brazil Chile Colombia Mexico Peru
Africa: Congo Egypt Ghana Ivory Coast Mauritius Morocco Senegal South AfricaEurope: Belgium Bosnia Croatia Czech Republic Finland France Germany Herzegovina
Hungary Ireland Italy London Netherlands Norway Poland Russia Serbia Slovenia Spain Sweden Switzerland Turkey United Kingdom
UNITED STATES170+ professionals17 offices
Boston Boise Burlington Chicago Dallas Denver Houston Los Angeles New York Orange County Philadelphia San Diego San Francisco St LouisTampa Washington DC
