There are a variety of reasons for me to be referred into a client. One of the most common is problems with the company’s accounting or the person/s performing the accounting. Often the owner/operator isn’t getting financial information that is timely or accurate. Often, they can’t judge whether the information is accurate, but their intuition tells them something isn’t right. Or they have doubts about their bookkeeper or accountant but have no way to judge the competence of the person in that role. Perhaps the information they are getting is internally inconsistent, or varies each month for unexplained reasons.
Other issues may be based on the performance of the company judged by the financial information compared to what the owner/operator thinks it should be. Often, I hear, “We seem to make money on every job, but at the end of the year it is a lot less than I would expect.” Or the company is profitable but can’t seem to ever pay off their line of credit.
Timeliness
Let’s deal with the timeliness issue. I’ve seen lots of companies who don’t produce financial statements until the end of the month following the month being reported on. I’ve heard every excuse for why it can’t be done sooner. These excuses might be valid for a short period of time. If this is a chronic issue, the bookkeeper or accountant is either stuck in a rut, doesn’t know how to change the process, doesn’t want to change the process, or is lying. Don’t tolerate this for long.
Accuracy
Accuracy of financial information is a far more complex issue than timeliness. Accuracy is mostly a matter of having the right people involved, meaning the proper education, training and experience. I’ve had my CPA license for over 40 years; I know what is required. Most business owners do not. Every situation is different, but generally you want to have each task done by the lowest-cost resource you can without sacrificing quality. In small companies, that usually means the accountant/bookkeeper will need to do some lower level tasks that they otherwise shouldn’t be doing.
Accuracy is also the result of developing sound practices, such is monthly closing checklists, reconciliation of accounts regularly, a system of internal controls and appropriate supervision. Some tasks may be automated, some may be outsourced. But with the right people and processes put in place, the owner/operator should be able to be confident that the information they receive, by the 15th of the month, is accurate. This, then, provides the basis for decision making.
Specific Issues
Here are some of the specific issues that I commonly see in substandard financials:
Cash vs. Accrual—Often a bookkeeper won’t know the difference between cash and accrual-basis accounting. Suffice it to say that the only way to measure profit is via accrual statements.
Correct Period—The basics of accrual accounting are to match the period revenue is earned with the expenses related to earning that revenue. Every accounting system is very sensitive to the dates attached to transactions. Having the wrong dates will frustrate getting meaningful information.
Gross Profit Margin—Gross profit margin is a significant performance indicator for most companies; it is the quantification of the value proposition. To calculate gross profit margin, one must understand what is included in Cost of Sales and what is Overhead. Which leads to…
Direct vs. Indirect Labor—For any service company, the separation of Direct vs. Indirect Labor is a challenge but extremely important. And that labor needs to be fully burdened or it is materially understated.
Payroll Accruals—Here’s a problem I see a lot. Often payroll periods straddle a month-end. Payroll is typically recorded when paid. The problem is that this doesn’t not match the Labor costs with the revenues earned from that Labor. Thus, the profit calculation is unreliable. With some training and some templates, often I can get a bookkeeper to do it correctly.
Overhead Allocation—Should Overhead be allocated to Cost of Sales? If so, which items of Overhead? On what basis is the allocation made? These are not simple questions and the results need to be meaningful for decision making.
And what if you’ve got accurate and timely financial information, but your profits aren’t meeting your expectations? That’s the topic of my next blog.
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