Working with Accountants

The first thing I want to get out of the way is that accounting does not have to be complex in a small company.  As you become huge it can become complex, but like many things people sometimes make things complex to hide the underlying facts.  It’s harder to make something complex simple than it is to make something simple complex.  I’m a huge believer that you want to make accounting as simple as possible.  Bean counting.  Don’t get me wrong it won’t mount to a hill of beans if you can’t get any beans which is why sales is important, and you can’t run your company through finance.  However, you improve what you measure and the better measurements and metrics you setup the better you will perform.  I will just discuss accounting in this post, not metrics.

I’ve worked where the mandate was to use accounting to try and “polish” the numbers to outsiders.  Two really bad things happen.

First, employees concentrate on gaming the system: negotiating to get accelerated payments on contracts, deferring expenses, etc. instead of improving the business.  This is insidious.  You might think it doesn’t hurt the business, but you concentrate on what you measure.  Instead of spending time fixing the problem you keep spending more and more time gaming the outcome.

Second is that no matter what, period end of statement you need to do at least as much gaming the next period as you did during the last period just to stay at the same level.  Everybody thinks they’ll ratchet back to normal but instead the normal line keeps getting further behind in the rear view mirror.

You are not going to get the best terms when potential customers realize (and they do) that you are willing to do deals for upfront money with strange terms.  They are going to exploit this to their advantage.  Similarly, suppliers serve those who pay well, on time.  I know I do.  The myth of stretching receivables is as short sighted of a cash flow tool as I’ve seen.  The interest rate of being known as a late payer is extreme and eventually results in C.O.D. terms, the discount and added value for paying on time has a very high interest rate.

I get people telling me all the time, accounting is too complex, I don’t understand it.  It is addition and subtraction I am going to keep the categories to those that you can count on your fingers.  If you can’t understand it you can’t be an entrepreneur.  No different than if you think sales is a dirty word.

Its starts with where to the beans go.  This everybody should understand….where do you get cash, where do you send cash.

Cash coming in:

1. Sales

2. New Equity Investment

3. Increase in Accounts Payable (what you’ve promised to pay but haven’t)

4. Increase in Debt

Cash going out:
5. Cost of Sales

6. Expenses to run the business

7. Increase in Accounts Receivable (what people have promised to pay you but haven’t)

8. New Capital Equipment (things that you buy that are going to give you benefit for a long time)

9. Taxes

NET CASH FLOW (Cash in – Cash out)

KEY TO SIMPLICITY: Now you just have to match these to a standard period of time.  You can make your life much easier by matching revenues and expenses to the periods you like to report.  For instance you can pay monthly, require all expenses to be submitted monthly, get your suppliers to bill you for their usage on a monthly basis, bill your customers on a monthly basis by pro-rating the first months invoice to end at the end of the month, setup a depreciation schedule monthly, etc.  In some ways people will say this is making your business run for accounting instead of the other way around.

Accountants are accustomed to taking whatever a business gives them and forcing it via journal entries, etc, into the correct period.   You just take those sales and defer income, pro-rate bi-weekly payroll, etc.  This adds a ton of complexity.  I have found it does not hurt the business to set it up on a monthly basis.  Then you have the exact numbers.  All invoices are paid at the end of the month, all customers are billed at the beginning of the month.  You know where you stand.

Income Statement

1. Sales

(5. Cost of Sales)

(6. Expenses)

( Depreciation of Capital Equipment)

(9. Taxes)

INCOME

Balance Sheet

Assets

Beginning Cash + Net Cash Flow

Beginning Accounts Receivable + 7. Increase in Accounts Recievable

Beginning Capital Equipment Balance +8. Increase in Capital Equipment

===============================================================

Liabilities

Beginning Accounts Payable + 3. Increase in Accounts Payable

Beginning Debt + 4. Increase in Debt

Equity

Beginning Equity +2. New Equity Investment + Income

Each Line item from cash flow only used once.  Income and Depreciation occur in both and you can think of them cancelling out (they are really just flowing between the two statements)  The reason why they call it a Balance Sheet is it must balance  Assets = Liabilities + Equity.  Either you add and then subtract the same amount from one side or you add or subtract the same amount to both sides.  So if your receivables go down by ($100k) your cash goes up by $100k.  If you get $1M in new investment.  Equity goes up $1M and so does Assets = cash by $1M.

Watch……..Here is how you can plug to cash flow from income.  I’ve struck out all of the items in income:

INCOME

1. Sales

2. New Equity Investment

3. Increase in Accounts Payable

4. Increase in Debt
(5. Cost of Sales)

(6. Expenses to run the business)

(7. Increase in Accounts Receivable)

(8. New Capital Equipment)

(9. Taxes)

+ Depreciation (non-cash income item)

NET CASH FLOW