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Reasonableness Test

September 17, 2015

Understanding what happens regarding your affairs and why is essential.  Unfortunately, many do not have a clue.  A reasonableness or sanity test is an effective way to review results and this applies to all of your activities.

When your investments rise or fall you should be able to grasp a reasonable explanation rather than believing it’s the effect of the herd stampeding…temporarily.  Also, all changes should be related to how you are affected based on your goals and long-term plan.  Think about it and focus on it – it only takes a couple of minutes – and see if what is occurring is reasonable and temporary or not reasonable and possibly a permanent shift in the paradigm.

When reviewing a business’ financial results, say increases or decreases in sales, relate it to actual quantities sold, number of orders shipped or how the production line was able to process the additional quantities.  See if it all makes sense.  If there is an inventory build-up, ask why and of what specific items and when they are expected to be sold.  If presented with a larger or smaller [Ugh!] bank account balance… ask about the cause for the change.  If you are told you are getting a much larger than expected tax refund [Yea!] ask why – perhaps you made much less than you planned [Ugh!].  You might have been told to pay more in estimated taxes than you should have been.  This might mean that your taxes are being mismanaged.

When a business is valued, there can be dozens of calculations presenting many different valuations, but are any realistic in that the owner would really sell for that amount and a buyer would actually purchase at that value?  A sanity test should give a sense of what might occur.

Buy-sell agreements often have valuations that are too low or too high, usually through neglect over the many years since the agreement was executed.  If too low, well, the remaining owner certainly doesn’t lose out.  But, suppose it is too high?  How is the remaining owner to make the payments?  And, if they cannot or do not want to be stuck with an unrealistic payout, might I suggest that the seller possibly would not be paid amounts they are counting on?  These amounts should be given a periodic sanity test.

Many organizations cannot have more than five or six essential items that are mirrors into their overall health and success.  Identify, quantify, get and use them and look at what they represent for reasonableness – each and every day because that is how often you should get them.

The bottom line is this.  You need to understand what is going on with your affairs, relate changes to what is really happening and understand what it means to you, understand the consequences and question changes that do not seem logical.

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