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….

Sustainability is the Key to Success

There are three key areas that most business owner under-value when it comes to driving sustainability in their business. It is safe to say that many small business owners never even think about sustainability in relationship to operational issues. But, sustainability is the key to success.

Three areas that a lack of sustainability will kill a business

Labor

Many managers think that high turnover is an issue of bad hiring practices. Generally, that is not always true. High turnover is attributed more to mismanagement after they are hired than making a bad decision during the hiring process. What does high turnover cost you?

Your employee never achieves optimum productivity. The longer someone does something the more productive they become doing it. They stop thinking about what they need to do next and start thinking about how to do it better. When they leave, you lose that productivity. You also lose some of your productivity as you go through the hiring process to replace them and the training and mentoring process to make the new employee productive. During the hiring process you are down two employees not just one.

Here is another important point to remember. People do business with people they like and trust. When there is no continuity in your customer facing employees this customer/client-employee bond either doesn’t mature or becomes broken. The emotional tie between your customers and your business is weakened. Referral business is the cheapest and most profitable lead generation any company can have. A lack of continuity can adversely affect referrals.

So what can you do from a management perspective to keep employees? First, understand that motivators and demotivators are not linked. The elimination of a demotivator does necessarily motivate. Providing a motivation does not always overcome a demotivating characteristic. You can give a person a promotion with more responsibility, which they crave, and they will still leave you because they don’t like the corporate culture. Removing excessive overtime might remove a demotivator, but it won’t motivate anyone to work harder. Understand what works and what doesn’t work. Create motivators while removing demotivators. Don’t assume that work is called work because it is work. Life can be better than that.

Everyone is different; learn what works for each one of them. People are not robots that need to be treated uniformly. Don’t let the lawyers convince you that everyone should be treated like a clone. Be fair with everyone, but create programs that reward people in ways that are unique to their needs. This takes knowing them, not a pleasant task for some managers. This also takes time to build programs that are more flexible. This might require too much thinking for some people.

Lead Generation

The second area that businesses waste a lot of time and money because of a lack of sustainability is lead generation. In this world of multiple electronic channels, which many seem nebulous at best, there is a tendency to try anything once. It takes time to fine-tune a new lead generation process. Owners need to take the time to fully understand the details of what they are trying to achieve before they start. They need to fine-turn their idea of a prospect. They need to fine-tune their idea of an offering. They may even have to fine-tune their perception of the buying process. Marketing is changing. People don’t buy the same way they did before. They have access to much more information. They have less geographic constraints to whom they do business with.

Plan on going through several iterations before you see results. Using a start-stop approach will only burn cash, confuse your employees and produce limited results as best. I don’t know how many times I have heard an owner say “We tried that and it didn’t work for us.” Did they have a plan for sustainability before they started, or were they just hoping to find something that might work?

Cash is King

Spend money only when you know, or reasonably expect, it will make money. Everything you do must have a tangible return on investment. Even branding strategies must have a payback somewhere out there, or why do it? Track what you spend against what you get back. The only way to sustain a program is if it generates as much income as expense. Otherwise, it will die a slow death as the cash runs out. Don’t throw money at something just to see if it might work. There is no such thing as discretionary income to a business, it’s all critical to the operation. You can’t bet money you can afford to lose, there isn’t any.

The key is to fully fund a program before you implement. Most businesses plan on using cash created by the program to fund the program. That is a recipe for disaster. Use the cash generated by the program to fund another program. Then you will see growth.

Think about sustainability. Think about how you will use what you are planning to do it replenish the resources you use to accomplish it. Ideally, it should pay you back more than what you use.

Businesses should Become Profitable Before they Become Big

Great article concerning the pit falls of creative accounting. Groupon reported earnings of $80M when they actually lost $114M.

Groupon Doomed by Too Much of a Good Thing

“Clayton Christensen would agree with the intuition that Groupon displays but ignores: businesses should become profitable before they become big. The best way to manage a fledgling business is for managers to be impatient for profit but patient for growth. Such a strategy limits an early venture's funding in order to force the business to develop a profitable business model and then invests heavily in growth once such a model is identified — Christensen terms such investments "good money" for incubating growth businesses and extols the strategy for three reasons.

• First, when a business is impatient for profit, managers are forced to validate their assumptions and demonstrate that customers are fundamentally willing to pay an acceptable price for the company's offering.
• Secondly, expecting a business to be profitable quickly forces it to keep its fixed costs low. Because a business's cost structure determines which customers it finds profitable, keeping these fixed costs low preserves strategic options for the company when it is choosing which customers to target.
• Finally, reaching profitability quickly ensures that when outside financing dries up, the venture can succeed on its own.”

We are so all consumed by winning that we lose sight of what score keeping is about. It’s about showing position and progress. It is not about the score, but what the score tells us. If things are not going as well as we would like or if we know according to the Sigmoid Curve that they will get worse before they get better, wouldn’t we want to know exactly what our position is? Wouldn’t we want to know as factually as possible the levers that we can push and pull to make things better?

I talk with many small businesses that I know will never achieve the level of success they should because of the way they keep score. In some cases it not just the way they keep score, they haven’t developed the skill to know what the score is telling them. They are too busy trying to look successful by redefining success.

Don’t fit the score keeping to your desired results…. Drive the desired result with better score keeping…

Service verse Sustainability, The Government Way

I’ve toyed with this idea for some time. It seemed we needed to wake up to what we as voters and taxpayer have allowed to happen. Our country is now run by two major corporations whose only true interest is sustainability. It’s no longer about the people or the nation, it’s about sustaining the life of the party. 546 people have become the royalty of the “republic for which they stand”. For the most part they hold themselves above the law and only answer to their parties. The voters for the most part only get to chose between the candidates the two parties have put forward.

Starbucks CEO Howard Schultz stated, "All it seems people are interested in is re-election,". "And that re-election -- the lifeblood of it is fundraising."

There are a number of similarities between corporate America and political parties. Both know to continue they need a revenue source that is sustainable over time. Otherwise the corporation dies out. For political parties that is fund raising. Build up a large enough war chest and new parties cannot afford to enter the marketplace. Both major political parties, combine, raised $1.9B during the 2008 election cycle. Corporations sell products and services to generate funds, what do political parties do?

Political parties use taxpayer money to fund projects targeted toward potential donors. Potential donors might be individuals, corporations or lobby groups. It really doesn’t matter to them, money is money. It would appear that the goal of legislation is primarily to garner good will among potential donors. One of reasons so much “pork” is added to every bill is to influence potential donors to contribute. Why else would congress add something like a library or bridge to a bill on healthcare or immigration? Why would a bill exclude certain groups from participating? Why would congress exempt certain groups from taxes or levies? It’s all about fund raising.

Both corporations and political parties engage in branding, advertising and public relations. One of the major differences is that corporations must reinvest their own money in product development to keep the revenues flowing. Political parties on the other hand have the ability to tax the general public to create “products” they can give to the market in exchange for donations. The money comes from the public but goes to the party. It’s a nice scheme. There is no direct connection between taking money from the tax payers… providing a “service” to the public… and collecting donations for the party. But those most willing to donate to the party are the ones who reap the most benefit from the “services” and generally don’t pay as much tax toward its delivery.

Almost 50% of those who filed taxes at the federal level paid no taxes. This does not include all of those who survive but have no taxable income, mainly due to entitlements. (not saying all entitlements are bad, just pointing out a fact) So the majority of the constituents (voters) are not currently paying for any of the services that they receive. From a business standpoint this is not sustainable. Why would congress pursue an unsustainable strategy? Because sustainability is about fundraising, not government spending. When worse comes to worse, they can just print more money or add more taxes.

The system has been broken for some time. It is now coming to a tipping point. Unfortunately the political parties will not chip in to bail us out. They will simply tax the voters and use the money to influence donors. It’s what they do…..

Personal Value in Economic Terms

One of the things that I constantly come back to when I hear dissension concerning compensations is “What was fair to you when you made the decision to take the job?” There is so much discussion concerning wealth redistribution and income parity. There have been numerous editorials and op-ed articles on CEO compensation. The NFL players union is in negotiations with the NFL owners concerning the distribution of revenue. There seems to be a lot of focus on the other guy. There seems to be a prevailing opinion that income is fixed and therefore compensation must be rationed between parties.

I was raised in the Midwest in a farm community. My thinking is somewhat molded by this experience. The concept of retirement is just not a real concept to a farmer. The farm never retires, there is always work to be done. It doesn’t provide medical benefits, 401K, or promotions. You can’t negotiate with Mother Nature to get a pay raise, try going on strike and see how that works. You make a commitment to a life style and you live up to that commitment or you change professions. Many children are leaving the farm because of that very issue. They expect medical benefits, they expect a retirement plan, they don’t want to work past 62, and they want their income to rise with the cost of living. These are all foreign concepts to farming.

I can’t tell you how many discussions I have had with employees who think their compensation is somehow relational to someone else’s. X-genres are the worst. “I’m doing all the work and fat old man in the corner office gets the big bucks.” And yet they agreed to do the work for the compensation offered. At the time they made the decision is seemed like a fair deal, or at least fair enough. Shouldn’t my concern be more along the lines of “I hope he makes a fortune because some day I’ll have his job…” Then figure out what it takes to get a job like his, build the prerequisite skills, knowledge and experience and apply. In economics, value is not derived by labor and materials. Value is created by demand in the marketplace. If I can find someone else who can perform your duties as well as you can for the same or less, then as a business stakeholder I have an obligation to consider them for employment. That job candidate should consider all possible avenues they can take to earn a living and take the most productive. What anybody else is doing only affects you as it relates to your decision to continue doing what you are doing.

I do think that many CEO, entertainers and sports figures are grossly overpaid, but that is because they don’t have a high level of value to me. I would never pay them at their current level. (Don’t misinterpret my statement as meaning they don’t have considerable value, just not as much in my view) The people who are paying them see their value or they wouldn’t pay them. If someone with higher value comes along then they will displace the current employee. That is how it works. The fact that I make less than them does not enter into the equation. My value and their value are independent.

An interesting read for those who want to understand economic value is “I, Pencil” by Leonard Read. He chronicles all of the independent people who help create the pencil. Everything from the tree growers, saw mills workers, and truckers, and graphite miners, and wax producers, and lacquer makers to Paper producers…. Everyone from all over the world…. Most of these people do not know they are involved. They all have a part. No one understands the entire process completely. This is how we fit in our perspective organizations. We all have a part. Each of us chooses to contribute or not. Each of us chooses if our compensation is enough or not. None of us, as individuals, depends on the value of others to create our own unique value. For a healthy economy we should all look for ways to increase our value independent of the value of others. If each of us increases our own value the economic ship will rise on the tide. If our goal is to drag others down to make ourselves feel better, no one will prosper.

It is not bad to want what others have. It is bad to want to take it from them as a form of compensation. Create value; create value in yourselves and others. Do not spend time trying to minimize the value of others. It will only bring everyone down.