The enslavement of the lower class or the unintended consequences of social engineering.

Do government programs meant to help the lower income worker actually make it more difficult for them to rise above government subsidies, thus thwarting their drive?

Conservatives and liberals are at the vocal polar extremes of public opinion. Most of us are moderates and keep our opinions to ourselves. Mostly  because there is no party to stand behind. I do fear that in the governments quest to save the lower class they have unintentionally built an economic system that further enslaves them. I'm a moderate so I give the government the benefit of the doubt. Liberals will say it's not true and conservative will say it is intentional.

Here's the makeup of the story. There are several moves the government has made that individually look like a good thing for the poor, but taken together it creates a spiral down system for their future. 

The government is trying to raise the minimum wage from $7.25 to $9.80 (or $10.10 based on who you are). That's a minimum 35% increase. On the surface that seems like a good idea, the lower income worker would get a substantial increase in income and maybe climbs out of poverty. There are some problems with it. The CBO (Congressional Budget Office) predicts that only 19% of the recipients of this wage increase are actually below the poverty level. 29% of the benefit would go to families already making over three times the poverty level. The projection is that the increase will be a net 3% to those below the poverty level. Add to this the negative real income effect of -.4% for the rest of the wage earners, the projected 500,000 lost jobs and the real net earnings is negligible. But this isn't the real problem. We'll get to that in a moment.

The second great idea for the lower class was subsidized insurance. Again, I am not being facetious, it was a good idea. But it did not address the unintended consequences. Low income people thrive on hourly work that is typically at or less than 40 hours a week. Under the new ACA mandate that limit will lower to 35 hours. The ACA also mandates taxes for employees in place of benefits, further raising the cost of employees that exceed the threshold. There is a lot of evidence that businesses will try to work around the requirement by limiting employment. One way to accomplish that is to hire more full time workers that will work in excess of 50 hours per week (and get compensated for it) and fewer hourly employees that work 30 to 40 hours per week. So the lower middle class or middle class will get higher quality employment and the lower class will be squeezed out. 

The combination of higher wages and higher ACA cost makes automation more appealing. The breakeven to replace employees with systems becomes more appealing. The jobs that will be automated are not the complex jobs that require analytical thinking, they are the repetitive manual jobs mostly populated by the lower class. McDonalds is already testing self serve ordering in California. This automation, much like self server check out and ATM's, further reduces job opportunities for the lower class. 

So where does the lower class find themselves. Well first, the job market for semi-skilled or no skilled employees is shrinking. The 500,000 jobs lost is part of it and automation of repeatable manual tasks is the other part. Add to that the natural limit of hours to avoid taxes and fees and when they do get a job it doesn't pay much. Here is another problem. When they get a job they pay taxes and they lose food stamps, welfare, and insurance subsidies. How much will they have to make to cover all of the lost income to taxes and the loss of government subsidies? Probably a lot more than $350 per week they would make at minimum wage and 35 hours. 

Now this isn't opposition to subsidies. You notice I didn't call them entitlements. In a prosperous civilized society there is a natural need to help other less fortunate.  I do see one of the unintended side effect of all of these programs is that the lower income group does not see a way off of subsidies through work. The inflection point it above their ability to achieve. So they are now locked in the lower class. The divide between a life on government subsidies and the life of the lower middle class is too great.  Society will eventually leave them behind.

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…..

Exactly How Do I Put a Value on Outsourced Accounting?

This is a stream of consciousness concerning the value of accounting for small businesses. I’m not an accountant, I’m a business guy trying to understand how to put a value on what I should spend for accounting. I am concerned with the adage that a man who represents himself in court has a fool for a client. Should I do my own accounting?

Aside from the obvious need to file taxes, it is stated that accounting provides four essential services to a small business. First, it records revenue obtained through the sale of products and services. Second, it provides an accurate record of the expenses associated with the sale of those products and services. Third, it keeps a record of monies owed in relationship to those expenses and finally it is a record of what the company owns.

This is very succinct. So what? Running a company is about cash. Knowing your profitability is important in the long term. However, staying in business in the short term is about cash management. Cash based accounting helps the owner understand their cash position more clearly in the short term, but makes it difficult to determine if the company will be profitable in the long term. There are four types of taxpayers that cannot use cash based accounting; Corporations over $5M, C Corp Partnerships, tax shelters and taxpayers with revenues over $1M requiring inventory. (You might want to talk with your tax preparer about reporting inventory if you are using cash based accounting). Accrual accounting is great for accessing the financial health of an organization over time, but tells you almost nothing about your cash position on a real time basis. Mid-size to large organization use accrual accounting with cash projection reporting. That is they run a separate set of books that keeps track of cash sources and cash uses.

Therefore, it would seem the best approach would appear to be accrual based accounting with a cash projection worksheet. Sounds like double work. I don’t have the time to do this myself. The way I save time is using summary data as opposed to detailed data. The problem with summary data is that it tells me almost nothing about how to run my business better. If I hire someone to do this thing for me, how does the effort pay for itself? I’m a guy that believes you don’t invest in a business expense that won’t pay itself back with profit. So how much net profit will I generate by having a bookkeeper or accountant? That’s a tough one….

Well for one thing, I know inventory consumes cash. Increasing the velocity of my inventory (that is the inventory turnover rate) will help me hold on to my cash longer. In my business, it won’t earn me much interest, but it may help avoid a late penalty on a payment due. Having a detailed analysis of how much I buy verses how much I sell, by item, will help me conserve cash. It might also help me identify waste, spillage or theft.

Knowing the profit margin on each product I sell could help me set pricing better. The market is going to drive many of my prices, so I might end up discontinuing products I can’t make money on. This could help me pay for help.

If my accounting could tell me how much profit-per-employee I make it might help me manage my labor cost more closely. I might also be able to assess how much I really spend on marketing if I can include all the ancillary expenses like meals and give-a-ways. Knowing how much I spend will help me understand its value better. All I really have to do is find a one per cent reduction in expenses or a two percent increase in revenues. With the right help it might be there…. There might even be more…. However, I’m going to have to find someone who understands both my business and how I manage my business… they need to understand both accrual based accounting and cash projections to really be useful..... what I don’t need is another employee to manage….

Importance of Operational Accounting in the Small Businesses

I read an interesting article this week written by John Nessel. John Nessel is the President of Restaurant Resource Group, a Boston-based consultancy providing financial tools and support services to independent restaurants and the hospitality industry. John’s number one red flag to restaurants failure is “Absence of a well organized and implemented accounting system.” He goes on to say “Printed copies of basic financial statements (Profit & Loss and Balance Sheet) are not adequate for this task because they do not verify the accuracy of the numbers presented.”

Luis Luarca of Allectus, a business management advisory, says “As proper and accurate accounting is the life blood of business, accurate and relevant accounting procedures allow for the opportunity to affect all aspects of business efficiently and effectively.” They both agree on some simple yet extremely important indicators of a poorly run business.

1. An overall lack of understanding concerning financial statements and their importance in business decision making

Understanding the technical definitions of items portrayed in financial statements is a long way from understanding what it really means and how an understanding of the meaning can be used to help run the business for efficiently and more profitably. The structure of the financial statements can mask potential risk and hide growing concerns. Not knowing what do don’t know can hurt you.

2. Over reliance on online bank balances to manage cash flow

The statement or online bank balance doesn’t tell the real story. It doesn’t tell what deposits haven’t cleared, what checks have not been cashed or what credit card transactions are not reconciled. More importantly it does not provide a vision into future cash needs. It is a point-in-time view of the health of cash. It can be dramatically different within minutes as transactions clear.

3. Inaccurate posting of financial information

This can run from simple transposition errors, to the more complex allocation error. One of the most overlooked concerns for small businesses is that the chart of accounts does not reflect the way the owner operates their business. A badly thought out chart of accounts can actually hide business problems until they are too late. Because of this, the allocation of expenses may not accurately show their impact on the business.

4. Daily and Weekly financial information is not routinely collected, reviewed and acted upon.

Many business owners are too preoccupied with data input to take the time to routinely apply a logic test to the financial information. Expand the effort to daily or weekly information gathering and little time is left to run the business. Owners should spend the majority to their time reviewing financial information for trends and taking action on those trends to improve the business performance. Instead many spend their time with the low level activity of capturing data.

5. The absence of a well organized and implemented accounting system that includes business specific Chart of Accounting, key performance tracking and repeatable procedures.

This seems to be the last thing any small business owners wants to take on. There are a lot of reasons for this. Tactical operational issues take precedence. There is a lack of understand as to the quantifiable benefits. There is a lack of interest or aptitude. All of these are the very reasons that a small business owner should look outside of their own expertise and time. This is a primary skill, much like tax accounting, that should be outsourced.

These trying economic times have brought to the surface ongoing operational issues that were previously covered by a better economy. Although poor profitability might have still been a problem, cash flow allowed these problems to go unaddressed. Many companies managed this through short term borrowing or lines-of-credit. Once credit was constrained and cash flow became an issue, operational inefficiencies came to light.

A lack of attention to good operational accounting may have masked many of these issues until they became a crisis. Crisis management is never a good answer. For some companies it became the only viable answer. The owner must take back control. To accomplish this there must be an in-depth review of how they currently account for financial activity and what that tells them or doesn’t tell them about the health of their business. This many times requires a third party that can objectively assess the environment exclusive of day-to-day operational bias and business ownership pride.

Transactional versus Transformational: Franchisers Lament Lack of Skills

The British Franchise Association (BFA) claims that the biggest obstacle to growth is finding people with the right skills to run their own outlet. A survey conducted in conjunction with NatWest revealed that a quarter of franchisers are finding it difficult to attract new franchisees because applicants lack the skills and funds to take on the job.

Dr. Michael Davis, who received his PhD in accounting at the University of Massachusetts, wrote a great article entitled “The Ten Lessons for Entrepreneurs”. One of his ten important lessons is that you can’t overestimate the value of good marketing, yet many small business people are woefully unskilled at this vital function. Most small business gets their marketing education at the hands of an aggressive sales person or at a half day seminar. Dr. Davis also extols the virtues of knowing finance and accounting as a primary tool for business decision making. The lack of this skill is a primary reason that many small business are overly optimistic about potential which leads to underfunding and collapse. Both of these skill sets are required to be successful. Small business manager don’t have the time or resources to stay current on finance, accounting, marketing, sales, operations, human resources and business practices.

One of the most important indicators of a successful franchise system is the repeatable methodologies embedded into the franchisee culture that both optimizes revenue and minimizes expense. Having a great brand, a great product and a great delivery system are critical to getting any franchise system off the ground. But it is repeatable methodologies that the franchisee can execute against that bring in new franchisees and helps existing franchisees grow. These repeatable methodologies must assume that there is a fundamental lack of business skills available within the franchise system to implement these methodologies. Doing so assures that the methodology will be mildly successful for most and wildly successful for the rest.

Most franchise systems provide excellent tools, if used properly and consistently, that help the franchisee become and stay successful. The problem arises when the franchisee either doesn’t have the skills required to use the tool properly and consistently, or doesn’t have the time. The tool, expensive to acquire, does not achieve its goal of improved profitability. Most of the time, the tool is blamed for the lack of success. Pragmatically the assessment is right. If the user can’t use the tool, then it’s the wrong tool.

Franchisor need to start looking at providing the required skills along with the required tools. The franchisor can either have the franchisee outsource these activities to the franchisor or an independent third party. There are some inherent benefits to outsourcing to an independent third party, but either will work. The franchisor should determine what high value activities MUST be done by the business manager for the business to be successful. They should then see which of those activities must be done exclusively by the business manager and what can be done by support staff. Most small businesses can’t afford a support staff. The franchisor should then help the business manager acquire the required support staff on either a part-time or ad-hoc basis. Every business must provide accounting and marketing expertise. Why leave it up to the franchisee to find the appropriate resource. If you know then have to have it, make it part of the value of your franchise by providing access to it.

The tools help reduce the cost of acquiring the prerequisite skills by automating as many of the process as possible. Automation reduces errors and cost. Tools can’t replace human involvement; they can only improve their results and reduce the cost.

The goal of any franchisor is to fill their franchise system with people who are not as focused on the day-to-day transactional processes as they are focused on finding transformational programs and projects that will take their business to the next level. Franchisors need to provide tools and the prerequisite resources required to operate these tools so that the business manager can solve problems before they become problems.