Wednesday, March 28, 2012

Don’t Lie to Yourself

I look at literally hundreds of Income Statements for small businesses monthly. As a company, we do comparative analysis of these to have a better understanding of best practices for our clients. I find an extremely disturbing trend among many of them; I would even say the preponderance of them.

The core of our practice is not tax accounting. It is operational accounting, using accounting information to make better business decisions. Most of our clients are under the $5M range. Many of them have revenues below $1M. Making good business decisions is incredibly important to them. They generally don’t have the safety net of large amounts of collateral (inventory, receivables or capital assets) to leverage into cash during down times. Managing their business on a daily basis is mandatory. It’s not a luxury. There is no room for big or repeated mistakes. These will make their lives miserable at best and close them down at worse.

In spite of this urgency for creditable information, most provide only lip service to their accounting. I won’t get into the challenge of getting timely and accurate answers today. This is an ongoing problem for busy business owners. But I do want to address the incredibly inconsistent and sometime illogical approach used by most small business when it come to capturing financial business information. All small business people inherently know that there are certain expenses that happen every month. There is rent, utilities and payroll. If you are a franchisee, there are royalties and national advertising fees. Whether you have actually paid these bills or not, you owe them. They are a drain on your profitability. They will eventually be a drain on your cash. Not posting them to your accounting system doesn’t make them go away. That liability still exists and needs to be dealt with. Not posting them distorts the view you have of your performance. It hides problems that will come back to bite you. Just do it and do it every month.

This is the obvious part and it still happens, what about the less obvious business practices that skew your financial view? Your Chart of Accounts (the way you itemize revenue and expenses) doesn’t match the way you do business. What do I mean by this? Most small businesses use the Chart of Accounts that came with the software and made simple changes. For example, Cost of Goods Sold (COGS) is unique for most businesses. A business may start with the Chart of Accounts for their industry and modify it for their particular business. You don’t want to start with the Chart of Accounts that came with the software because it doesn’t fit the way you do business. It actually doesn’t fit any business, it’s just an example to get you started. This is true for labor cost, inventory and other items you manage on a daily basis. If you have a service business, you really should go to some level of job-based accounting so you know what jobs are profitable and which aren’t. You can’t sell at a loss and make it up with volume.

The bottom line is that we have seen very few new clients that didn’t think their accounting was at least in the ball park. We have had very few new clients that we didn’t have to perform extensive re-coding. We’ve had clients that we had to go back as much as 18 months to clean things up. These good, intelligent people run good businesses. It’s not about their intelligence, drive or commitment to their businesses. Their forte is not accounting. Their accounting never told them anything about running their business so they didn’t expect it to. They wanted to make sure they didn’t overpay taxes, that was about it.

I can’t help to improve some of the businesses I talk with because their numbers don’t make sense. We had a client that sold more products then they brought into inventory every month for as long as they were clients. We’ve had clients that’s COGS exceeded sales. We’ve had clients that posted negative payroll during periods. We helped them identify the problems and in most cases solve them. Some of them decided they didn’t want to fix the problem for personal reasons. They’re not clients today. That’s a liability we weren’t willing to accept.

If I can leave you with one message….Never lie to yourself…. You deserve better…. Understand the truth about your business. Initially it may be uglier then you thought, but it is the only way to get better. If you don’t feel you have either the objectivity or skill set, bring in a third party. The truth will set you free…..

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