After the end of the year, it’s time to do a deep clean of your business books. Here’s a checklist to help you with this very exciting task!
Businesses often have a life cycle similar to people. In my last post I described this life cycle and gave some tips on how to know if it’s time for your business to grow up from high-growth but awkward teenager to more stable adult.
Some teenagers never grow up. Uncle Rico is stuck in 1984 (although I heard the Broncos may be giving him a second chance…). But due to biology and societal expectations, most teenagers find their way into adulthood.
Businesses don’t have the same outside influences. It’s up to you to intentionally grow it up. Growing up often means turning some attention to the boring stuff you neglected while focusing on sales growth.
You know it’s time to grow up, but how do you do it?
You shouldn’t try to do it all yourself. In fact, you shouldn’t try to do much of it. But you need to make sure it’s getting done.
Task someone on your team who is capable of taking the lead, or hire someone to help. An experienced, full-time person might be expensive, but you can hire a consultant to whip you into shape and inexpensively monitor your business going forward.
Not that I’m biased, but an experienced, part-time CFO would often be a good choice for this role.
Here are some areas to consider.
Are you legally structured correctly? Are there things you can do to increase liability protection?
Would it be better to move real estate to a separate legal entity? Similarly, do you have unrelated business units that can be spun out separately? Structuring like this can prevent lawsuits against one part of your business from affecting other parts.
Unfortunately, lawsuits are a part of doing business. I don’t think I’ve been involved in a business that hasn’t been involved in some kind of lawsuit.
Have your auto, property, general/product liability, director/officer liability, workers compensation, and/or professional liability insurance policies kept up with your growth?
Are the limits and coverage adequate and correctly structured?
Hopefully you’ve been handling taxes correctly from the beginning, but part of growing up is making sure. Have an accountant review income tax, sales tax, payroll tax, and property tax filings and processes to make sure its all being done correctly.
When you’re not making much money, tax penalties and interest caused by mistakes may be minor, and you’re less likely to be audited. This changes as you grow.
Believe me, you don’t want to be audited before you’ve grown up.
Cleaning up your books is part of growing up. Can you rely on your books to make good, timely decisions?
If you don’t choose to clean up, you’ll eventually be forced to clean up by government agencies or capital sources like banks or investors.
Like many other messes in life, messy books are much less expensive to avoid than to clean up, so the earlier you grow up your accounting the better.
Startups usually hire based on desperation. Stuff to do is piling up, and they quickly throw bodies at the piles.
You need to be more intentional as you grow up, especially when you’ve grown past the point of being involved in every step of every hire. Those handling the hiring need to pay more attention to cultural fit, on-boarding, and a host of other HR and payroll issues.
This is not an exhaustive list, but it gives you an idea of things to think about as you try to grow up.
You or your person overseeing the growing up doesn’t need to be an expert in all of these areas, but they do need to know enough to communicate effectively with experts like outside attorneys, insurance brokers, tax accountants, etc.
Just a final thought. In this post I’m observing typical juvenile business behavior and giving advice on how to grow up. Typically, startups wait until after a period of high growth to start worry about these less exciting issues.
However, I’m not recommending they wait. As long as you don’t let it stifle your growth (and not have a business to grow up with), the sooner you grow up the smoother your growth will be. When it comes to legal, insurance, tax, accounting, and HR, an ounce of prevention is worth a pound of cure.
The trick is to prevent business-killing problems without preventing business-making growth.
Question: What other areas are involved in help a business grow up?
In my last post I described the benefit of hiring contractors while bootstrapping a startup. I also explained the tax obligation that goes along with hiring contractors, which is to file a 1099-MISC form for contractors that meet certain requirements. I also mentioned severe penalties for not meeting this requirement. In this post, go into more detail about who to issue 1099-MISC forms to, how to file, and what the W9 form has to do with it.
Who do I send a 1099-MISC to (and what does the W9 form have to do with it)?
There’s a long list of requirements for who businesses have to send 1099-MISC forms to, and I encourage you to familiar with the rules so you know what applies to your business. This post is focused on contractors.
You must provide a 1099-MISC form to contractors if they meet the following criteria:
- they provided a service, not a product
- you paid them at least $600
- their business is not classified a corporation (C-Corp, S-Corp, or LLC filing as a C- or S-Corp)
- the corporation rule doesn’t apply to attorneys: you must provide a 1099-MISC form for all attorney fees
- you didn’t pay with a credit or debit card
To find out whether or not the business is a corporation and to get their business address and tax ID number, you should ask the contractor for a W9 form before making your first payment. An electronic copy is fine - you don’t need paper.
The W9 is a simple form that states the business or individual name, tax classification, address, Tax ID. Most contractors should already have the form on file, and if not, they should be able to quickly produce it. Here’s a link to the form.
You don’t need to request a W9 if the business has “Inc” or “Corp” at the end of their name. That tells you they are a corporation.
If a vendor refuses to provide a W9 form, you are required to withhold 28% of your payment and remit to the IRS (or better yet, don’t hire them!). If you don’t issue a 1099-MISC (you can’t without the information from the W9), you could be responsible for that 28% on top of the full payment already made to the contractor.
How do I file a 1099-MISC form and what is the deadline?
Like filing your tax return, there are many ways to file a 1099-MISC. You can mail in paper forms, but I recommend using your accounting software or another online service.
For example, some versions of Quickbooks Desktop and Online allow you to flag vendors as 1099 vendors and save their address and tax ID. At the end of the year it’s very easy to file with information already in the system.
Even if your accounting software doesn’t issue 1099’s, other services may integrate with your accounting software so you don’t have to enter the address and Tax ID, and amount for each vendor. Tax1099.com is a service that integrates with most accounting software.
Other services include Intuit’s standalone 1099 filing service and expressirsforms.com.
These services are very inexpensive (around $3/form) and well worth the cost.
The deadlines are as follows:
Jan 31 (or next business day): provide the 1099-MISC form to contractors
Feb 28: paper file forms with the IRS (not required if electronically filing)
Mar 31: electronically file the forms with the IRS (recommended)
It’s after the end of the year and I didn’t request W9’s. What do I do?
- Run a report in your accounting software to figure out how much you paid each vendor in the previous year.
- Make a list of vendors who you paid more than $600 for services and aren’t obviously a corporation.
- Request a W9 from each one (attach a blank form for convenience)
- See above for filing options
- Start a process now for collecting W9’s from each new contractor!
What if I haven’t filed 1099-MISC’s in the past?
You have some risk of tax liability to the IRS. In an audit the IRS will identify vendors you paid for service. Each vendor you don’t have a W9 on file for and you didn’t send a 1099-MISC forms will have to prove they included your payment in their tax returns.
If they didn’t report your payments or can’t/won’t prove it, the IRS can bill you for 28% of what you paid to the vendor (good luck getting that amount back from the vendor).
If you haven’t filed 1099-MISC’s in the past, start now. Make collecting W9’s a standard part of your process for hiring consultants (don’t make a payment until you get one). Make the filing process easy each year.
Although this requirement is convenient, don’t get on the wrong side of the IRS by neglecting it.
Question: How do you make issuing 1099’s easy each year?
Bootstrapping entrepreneurs hire employees only when absolutely necessary. They hire to alleviate significant pain, not because they might need the employee in the future. Building a team of great employees is key to building a successful business. Every leader knows that. However, taking on the cost and commitment of employees too early can hold back and even kill that success.
To lessen the risk of hiring too many, too soon, most entrepreneurs start with contractors. A startup entrepreneur wouldn’t hire a full-time accountant or an in-house lawyer.
Contractors can be anything from a freelancer with a specialized skill, such as a graphic designer, to a large businesses that provides certain services, such as a law firm.
Hiring contractors allows you to avoid many of the costs and complexities of hiring employees. You don’t have to follow labor laws intended for employees, register for payroll accounts with state tax agencies, or pay employer payroll taxes.
However, hiring contractors still comes with tax-related consequences. This post is for a United States audience, but other countries might have similar requirements.
First, you must be careful not to classify someone as a contractor when they should be an employee. The IRS doesn’t like that. They will charge you for the payroll tax you should have paid (plus penalties and interest). But that’s a subject for another post.
In this post, I want to make sure you are aware of another tax risk with contractors.
Did you know that if you don’t handle payments to contractors correctly, you may have to send the IRS 28% of whatever you paid the contractor (on top of what you already paid them)?
The IRS wants their (our) money
Here’s the deal: the IRS has a harder time collecting tax from contractors than employees.
Employees have tax withheld from every paycheck. In most cases these withholdings are more than what the employee owes, which is why most people get a tax refund each year.
The IRS doesn’t have that luxury with contractors, so they came up with a system that increases the likelihood that contractors will report and pay taxes on their income.
What is the 1099-MISC form?
The system revolves around the 1099-MISC form and specifically Box 7 of that form, Non-employee compensation.
You must send to employees and file with the IRS W2 forms after the end of each year. Most business owners don’t need to think much about this because payroll service companies handle it all.
Similarly, you must send to certain contractors and file with the IRS the 1099-MISC form. Usually, this process is a little messier than payroll.
Not every contractor needs a 1099-MISC, and most businesses don’t pay all contractors in the same way. Some might be given checks, some might be paid through the payroll system, and some might be paid by credit card.
Issuing 1099-MISC should be an easy process if properly planned for, and the consequences for not doing so are severe. If the IRS finds that a contractor didn’t report and pay tax on your payments, you will be responsible for 28% of what you paid them (plus penalties and interest) to compensate for the lost tax revenue. Good luck collecting this from your contractor.
In my next post, I will go into more detail about who to issue 1099-MISC forms to, how to file, and what the W9 form has to do with it.
Most businesses deal with foreign currency exchange to some extent. It could be as simple as travel to foreign countries for conferences or as significant as paying millions of dollars to overseas suppliers. In my last post I introduced some terminology, warned about the outrageous foreign exchange rates that banks charge, and recommended you set up a foreign exchange service for your business.
In this post, I’ll give one more transaction cost tip, and then I’ll move on to a practice that can save you much more than a few percent on transaction costs.
Where possible, use foreign currency bank accounts and debit/credit cards
If you frequently travel to or make purchases from a foreign country, I recommend opening a bank account denominated in that currency. This allows you to minimize transaction costs by periodically buying the foreign currency to deposit into that account.
Having a debit card on that account, or a credit card linked to it, allows you to make routine purchases, such as meals while traveling, without paying transaction costs each time.
Using your local debit or card or credit card for foreign currency transactions comes with terrible exchange rates and sometimes additional fees for each transaction.
The bank in your country might offer accounts in different currencies. For example, most Canadian banks offer accounts in both CAD and USD. Some banks also allow foreign citizens to open accounts. For example, Wells Fargo in the US allows Canadian citizens to open accounts.
Rules and conditions vary across banks, currencies, and countries, so this may not be possible in all situations.
Hedging is not just for gamblers and big businesses
Having a foreign currency bank account is an example of a simple hedge.
Hedging is basically a way to protect yourself from changing values of foreign currencies by locking in the current rate for future transactions. While minimizing transaction costs can save you a few percentage points, hedging can save you much more than that.
Foreign currency values fluctuate wildly. The Canadian dollar has lost about 30% of its value against the US dollar in the last year (late 2014 to late 2015).
If you need to purchase $100,000 USD with CAD, it would cost you $30,000 CAD more now compared to a year ago.
Using the bank account example, if you had bought USD with CAD a year ago and kept it in a USD bank account, you would have saved yourself $30,000.
In hindsight that would have been a good idea, but there are two problems. First, you tied up $100,000 for a year. Second, the USD could have declined against the CAD instead of the other way around.
A better way to hedge is to purchase a hedging instrument.
I have been involved in small businesses with cross-border money movement for almost 10 years. I didn’t even consider hedging for the first few years because I thought the costs and complexity wouldn’t be worth the benefits.
However, our foreign exchange service showed me how inexpensive and simple foreign exchange hedging can be. They approved the company for a given credit limit and suggested I hedge about half of my expected needs over the next 90 days. I simply told them how much I wanted to hedge, and they created a contract allowing me to exchange funds at a given rate at any time over the next 90 days (called a forward contract).
The only cost was the exchange rate would be a fraction of a percentage higher than the spot rate. This is a small price to pay given the potentially huge swings in exchange rates.
Over the first few months the Canadian dollar weakened, and the hedge saved us several thousand dollars.
You can save your business bundles by being intentional about foreign exchange through minimizing transaction costs and hedging against future fluctuation.
Question: How have you used hedging to protect your business against foreign exchange fluctuation?
Most businesses deal with foreign currency exchange to some extent. It could be as simple as travel to foreign countries for conferences or as significant as paying millions of dollars to overseas suppliers. If you are not intentional about minimizing the cost of exchanging foreign currency, you are probably paying 2-5% more than necessary on every transaction.
If you spend $5000 on a foreign conference, that’s $100-250 more out of your pocket than necessary. That may not sound like a lot, and maybe it’s not a big deal if your only foreign experience is once a year. But these extra costs add up quickly.
If you pay a million dollars to a foreign supplier, you’re paying $20,000-$50,000 more than you need to. That’s significant.
First, some terminology
For me to write concisely about foreign exchange, we need to understand some terminology. I’m not a foreign exchange expert, so my explanations might sound elementary to an exchange trader, but it works for the purposes of this post.
The actual exchange rate between two currencies is not an exact science. The published exchange rate between two currencies can be called the spot rate. However, when you actually exchange currencies, you never pay exactly the spot rate.
Those who trade currencies, such as banks, make money on a spread, which is the difference between what they are willing to buy the currency for and what they sell it for. The larger the spread, the more the trader makes (buy low, sell high).
For example, if a spot rate between Canadian dollars (CAD) and US dollars (USD) is 0.80 USD/CAD, is a bank might be willing to buy a $1 CAD for 75 cents USD and sell it for 85 cents. Their spread is 10 cents.
If you exchange foreign currency, you want the rate you exchange at to be as close as possible to the spot rate. As a benchmark to keep in mind while reading this post, you should never exchange foreign currency for more than about 0.5% from the spot rate (unless it’s such a small amount the convenience outweighs the cost).
For example, if you are buying CAD with USD and the spot rate is $0.800, you should not pay more than $0.804 USD for the $1 CAD. If the amount exchanged is in the thousands of dollars or more, you could pay as little as 0.1-0.2%.
With the technicalities out of the way, here are some tips for saving money on foreign exchange. These actions aren’t reserved for big businesses. Even the smallest of businesses can easily take these steps.
NEVER let your bank exchange foreign currency (at least at their published rate)
Okay, “never" might be too a strong a word. If you need $100 worth of foreign currency, $2-5 may be worth the convenience of a local bank.
As I write this, Wells Fargo’s online rates say they will sell you $1 CAD for $0.7703 USD. The spot rate is $0.7337. This means their rate is 5% more than the spot rate (remember the benchmark is 0.5%, 1/10 of what they are charging). If you buy $10,000 CAD with USD at this rate, you are spending at least $450 more than you should be.
Like any good business, most banks are willing to negotiate their rates, especially for large amounts. Their published rate is just a starting point and what they will charge if you don’t ask.
Every bank is different, but they should be willing to go down to 2-2.5% above spot for small transactions or under 1% for large transactions.
Banks may be okay if you exchange foreign currency infrequently and in small amounts, but to avoid banks, let’s move on the next tip.
Get an account with a foreign exchange service
Many foreign exchange services offer rates at a fraction of the price of banks. This is where I get the benchmark of a maximum of 0.5% above the spot rate.
There are many services out there, but I am most familiar with GPS Capital Markets in the US and Western Union and Citizens Bank in Canada. Some banks have in-house foreign exchange services that provide better rates than their retail branches, but I’m not very familiar with those options.
Here is the actual exchange rate schedule for a foreign exchange service I recently set up for one of the businesses I work with.
$0 -$5,000 0.50%
$50,000 + 0.15%
They have no minimum transaction amount or minimum volume over time. It was easier to set up than a bank account.
Unless you have a physical location near you, these services doesn’t work if you need a small amount of foreign cash for a trip. But they work great for paying foreign suppliers, receiving funds from foreign customers, or moving money between your own banks accounts in different currencies.
The process varies, but in general you deposit or wire funds to their account in one currency, and they wire or deposit the funds to their final destination in the foreign currency.
I work with a company that has locations in Canada and the US. Most of the revenue comes in Canada and most of the expenses are in the US. The foreign exchange service I use has an account at the same bank we use in Canada.
Any time I need to move funds from Canada to the US, I fax a request to the bank to transfer Canadian funds from our account to exchange service account, the service exchanges the CAD to USD at a great rate, and they wire the USD to our US bank account. It takes me about 30 seconds to send the fax and notify the exchange service, and a few hours later the funds appear in the US account.
That’s enough foreign exchange fun for now. I’ll save more tips for my next post.
As you can see, even the smallest businesses can save a lot of money on foreign exchange by taking some simple steps.
Question: How do you save your business on foreign exchange?
Most business owners would rather focus on building their business than dealing with accounting. They know it’s important to have good numbers to base decisions on. They know they need to file and pay their taxes accurately and on time. But many struggle to make it happen without getting bogged down in the details themselves.
In a perfect world, companies' accounting should be accurate and up to date without requiring the business owners to think about it. They should be able to review the key metrics as needed and be confident that all other details are being taken care of.
However, many business owners operate far from this ideal. In several years of helping small businesses with accounting, I’ve seen two common mistakes that business owners make.
At one extreme, business owners pay too little attention to their accounting.
One mistake I see at this extreme is turning over accounting to inexperienced bookkeepers.
They may not realize there’s a problem until they have serious issues. They may have tax agencies coming after them for inaccurate or unpaid taxes. They may get in a cash crunch because they don’t understand their numbers.
For example, a business may take prepayments from customers, which makes their bank balance look good at times. If the customers aren’t profitable, the cost of providing the product or service will eventually drain the cash from taking prepayments.
I worked with a company that had grown rapidly to several million dollars per year in sales. As they grew, they didn’t invest in their accounting. They had hired and lost a series of low-cost bookkeepers and paid little attention to what the bookkeepers were doing. Taxes weren’t filed accurately. The books didn’t accurately show their profitability. It took a lot of work (and a high cost) to clean up the mess and put proper procedures and people in place.
Small business accounting doesn’t have to be complicated and expensive. Most business don’t even need a full-time, experienced accountant. However, it takes someone experienced to set up the systems and monitor less experienced staff.
At the other extreme, business owners try to do the accounting themselves.
Even if business owners can do their own accounting, it doesn’t mean they should. They have much more important things to do, like build the business. They shouldn’t get bogged down in the accounting details.
I saw this with another business that had grown to several million per year in revenue. The owner knew accounting basics, and as the business grew he continued to handle all the accounting. He was spending almost half of his time entering bills, sending checks, reconciling bank accounts, etc. The accounting was being done well, but it was taking the owner away from more important activities.
I helped him set up a system in which a part-time experienced accountant trained and supervised a low-cost, part-time bookkeeper. Now he hardly has to think about accounting, and half of his valuable time is freed to build his business.
A better way
There is no right way to find the balance between these extremes. It depends on the nature and size of the business.
At the small and simple end, the company’s tax accountant may be able to advise a team member who spends some of their time taking care of the day-to-day bookkeeping.
At the large and complicated end, some businesses may need one or more full-time experienced accountants led by a full or part-time CFO.
Most small business are somewhere in the middle.
A structure I’ve seen work well is to contract with a part-time, experienced accountant. This accountant could help the business’ own staff, such as an office manager, handle the accounting. Alternatively, the accountant could completely take over the accounting function, typically with his own bookkeepers.
I'm biased because I provide these part-time services, but it works well in the companies I’m involved with.
Accounting is important, and business owners need to make sure their accounting is handled properly while not spending much of their time thinking about it.
Question: How do you handle your small business accounting?
Choosing the right accounting software for your business is an important exercise for small business owners. It may not be the most exciting exercise, but the choice will affect your business every day going forward. Plus, switching is difficult if you make the wrong decision.
Your business runs on accounting software. How well the software fits your business will determine how much time and money you spend on separate products and processes. How well the software works will be a big factor in how productive (and sane) your team is. The information you rely on to make decisions needs to be accurate without taking too much extra work to generate.
I’m a big fan of online accounting software, or software as a service (SaaS), as opposed to desktop software. With SaaS you don’t have to manage software installations or data on your own equipment.
Two of the leading accounting SaaS products for small business are Xero and Quickbooks Online (QBO).
I wrote a post almost a year ago extolling the virtues of Xero. I criticized Intuit for how slow they were to release QBO and build out its features.
However, I recently noticed that QBO has rapidly improved. I think it’s time to update my opinion.
I still love Xero and use it for most of the companies I’m involved in. It was good when I started using it five years ago (much better than QBO), and it has improved since then. QBO was extremely bare bones at the time and didn't come close to having the features we needed, such as bank feeds and multi-currency.
I recently took another look at QBO, and it has come a long way in the last 5 years. As far as I can tell, it has all the features of the Quickbooks desktop version, and possibly more. It just added multi-currency support and redesigned many of its standard reports.
Here is a comparison between Xero and QBO in a few key areas.
1. Data entry
Quick and easy data entry is essential, especially for high-volume businesses. Even a few extra seconds on each transaction adds up over time.
Both Xero and QBO have bank feeds, and the process for entering transactions from the bank feed is similar. Both allow you to create new transactions or match to existing transactions right from the feed.
Xero has a feature called cash coding. Cash coding puts all new and unmatched transactions in a list with fields that can be edited without going to a new screen. This allows you to quickly tab through and assign a name, account, and description to a long list of transactions.
2. Flexibility and ease of use
Xero is easy to use, but it is not very flexible. Usually there is only one way to do something. In addition, you can’t edit some transactions. Instead, you have to delete and re-enter if you make a mistake. For example, you can’t edit bank transfers or payments applied to bills/invoices.
Also, you can’t apply one payment to multiple bills denominated in a foreign currency. You have to pay each bill separately, and then match the separate payments to the actual payment in the bank statement.
QBO is extremely forgiving. As far as I can tell, any transaction can be edited. Further, any transaction can act as any other similar transaction. For example, you may add a bank feed withdrawal as an expense. After reconciling the bank account you may realize the withdrawal should have been a bill payment.
You can simply change the name on the expense to the vendor name and change the account to Accounts Payable. This creates a credit on the vendor account, and then you can apply the credit as a payment against the bill. No need to delete the expense, re-enter a bill payment, and re-reconcile the bank account (as you would have to do with Xero).
QBO also has familiarity going for it. Many accountants are familiar with Quickbooks desktop version, and the QBO functionality is similar.
Software bugs are frustrating. QBO seems to be more buggy to me. I don’t have specific examples, but often screen don’t load properly or features don’t work as expected. Sometimes the Xero site will go down for a few seconds, but I don’t remember coming across any bugs.
Neither product has the great reports compared to more expensive systems, such as Netsuite. Of course, you can find all of the standard reports like Income Statement, Balance Sheet, Aged Payables, Aged Receivables, General Ledger, etc. However, customization options are limited.
Xero has better options for customizing individual report layouts. You can group accounts together and create various detail and summary templates. It has the awesome feature of being able to use the same template across multiple companies. For example, I customize the layout of the income statement and balance sheet based on the range of account codes (from the chart of accounts). I use the same chart of account rules in most companies, which allows me to use the same template.
QBO has a wider range of reports and better ability to drill down into detail. They have also recently released a new set of nicely redesigned reports.
Winner: it’s a toss-up with a slight edge to Xero
5. Payroll integration
Both products have integrated payroll. Xero’s service is relatively new and is being gradually rolled out to US states, but it still has a ways to go. I haven’t used Xero payroll so I can’t speak authoritatively, but it appears that state and federal filings are not automatic (a big drawback in my opinion).
QBO has both basic and full service options. I use Intuit full service payroll for several companies, and I find it extremely simple, easy to use, and inexpensive. Tax filings are completely automated. All you have to do is enter hours (if you have hourly employees) and press a button to submit payroll.
As you can see, Xero and QBO have their strengths and weaknesses. Until recently I would have recommended Xero hands-down. However, QBO, with its recent improvements, is now a contender.
Rather than recommending one over the other, I suggest signing up for a free trial and exploring the features that are most important to your business.
If you are moving from Quickbooks desktop, you can automatically convert the Quickbooks data file to either Xero or QBO. This will allow you to test the software with real data. You can re-import the data file when you make a decision and are ready to move forward.
Good luck with your accounting software search!
Question: What other accounting software should small businesses consider?
Small business accounting is like staying healthy. Everyone knows the importance but few enjoy it. Although important, usually only a crisis makes it urgent. Staying reasonably healthy only requires that you understand (and follow) a few basic principles. For example, excess sugar and processed foods are bad for your health. Walking 10,000 steps per day and elevating your heart rate for 20 minutes, 2-3 times per week is a good exercise plan.
Likewise, you only need to know a few basic principles to maintain a good accounting system.
At a minimum, you need to understand the accounting roles needing to be filled and then assign people to fill those roles. You may not even need to hire anyone. Think of your accounting team as a collection of roles that need to be filled and not necessarily a collection of people.
Your accounting may be so simple that you fill the roles to start with. You may have another team member who can handle a few extra duties. You may hire a part-time bookkeeper for a few hours per month. It doesn’t matter how. What matters is that these roles get filled from the beginning (before a crisis).
Getting your accounting done doesn’t have to be complicated or expensive. You just have to know what to do.
The followings are accounting roles that need to be filled in most businesses:
Chief Financial Officer (CFO). Don’t be intimidated by this title. It takes a fairly large company to need a full-time CFO, and it may be a while before you formally give this title to anyone. The title simply describes a role that needs to be filled.
Someone needs to oversee the accounting. Someone needs to make sure the accounting roles are filled effectively. Someone needs to make sure the books stay clean. Someone needs to make sure the data provided by the books is both accurate and interpreted correctly. Someone needs to use the numbers to advise other leaders on decisions. Someone needs to make sure you are complaint with tax, labor, and other laws.
In the beginning, this role may be filled by you as the business owner, ideally with help from a CPA or contract CFO. Someone needs to make sure the rest of the accounting function is operating effectively.
Bookkeeper. This function makes sure the books are accurate at least monthly. The bookkeeper should follow a month-end checklist to make sure all transactions get into the accounting software and the bank accounts are reconciled. Depending on the nature of the business, they may handle other transactions such as fixed asset purchase/disposal/depreciation, inventory adjustments, loan and investment schedules, etc.
Once the books are accurate for the month, they can run financial statements and other reports helpful to management.
Accounts Receivable. This function is responsible for the process from customer order to customer payment. This role is simple in a retail store with only point of sale transactions. However, in many businesses customers get billed for products or services and then pay on agreed terms. Someone needs to make sure customers get billed accurately and pay on time. They also need to make sure payments get entered in accounting software so customer accounts remain accurate.
You won’t be in business long if you don’t pay attention to this role. Customers will be frustrated by inaccurate billing and statements. Failing to invoice a customer means lost revenue. Cash flow will suffer if customers don’t pay on time.
Accounts Payable. This function is responsible for the process from making a purchase to paying for that purchase (the mirror of Accounts Receivable). This usually involves receiving bills, verifying they are legitimate, entering them into accounting software, and making sure payments are on time and accurately entered. Even point of sale purchases require the receipt to be tracked and the transaction to be categorized accurately in the books.
HR/Payroll. The function handles hiring and compensating employees. It makes sure new employee paperwork is complete. It makes sure working conditions and practices comply with labor laws. It makes sure employees are paid accurately and on time. It administers employee benefits. Perhaps most importantly, it makes sure payroll tax is remitted accurately and on time.
This function can be completely outsourced to a professional employer organization (PEO). At a minimum, every company should outsource payroll. An abundance of service providers make payroll extremely cheap and easy. You shouldn’t spend more than a $100 and a few minutes per month on payroll if you have a small team. Company like Zen Payroll and Intuit do everything from calculating taxes to direct depositing pay into employee bank accounts to submitting payroll taxes.
Putting it all together
If these roles' workload doesn’t justify new full-time employees, how do you fill them?
I’m biased because this is the work I specialize in, but I recommend hiring a contract CFO to help you set up accounting systems and plug your existing team into the necessary roles. The future headaches you’ll avoid is well worth the hourly rate you’ll pay for an experienced CFO. It shouldn’t take very many hours.
For example, many businesses already have some kind of administrative assistant. A CFO can set up a system simple enough to be run by someone not training in accounting. The admin can handle 99% of the work, and the CFO can be available as needed to answer questions and handle the more complicated transactions. A contract CFO combined with low-cost administrative staff can inexpensively handle the accounting for most small businesses.
That said, there is no one-size-fits-all approach to accounting. Business owners must first recognize that a good accounting system is important, and then they must understand the roles that need to be filled. From there they can build a team to make it happen.
Question: What tips do you have for running small business accounting?
In my last post, I wrote about why it’s important to keep your business books clean. Accounting is one of those mundane details that most business owners don’t like to deal with. They would rather spend time building and selling their product or service. However, it is important to invest some time, attention, and money in keeping your books clean. This will allow you to make better decisions and help you avoid costly and distracting tax nightmares and clean-up projects.
Hopefully I’ve convinced you that it’s important to invest in clean books.
Now where do you start? Unless you have an accounting background or lots of business experience, getting started may be intimidating.
The answer is to start by creating systems. Creating a system begins with defining roles that need to be filled and then building a team to fill those roles.
Before diving into accounting systems specifically, I want to talk about the importance of creating systems in all areas of your business.
In business and life, the key to creating order out of chaos is systems. Systems allow us to automate the mundane so we can focus our greatest efforts on fine tuning rather than cleaning up messes.
It doesn’t mean smart and skilled people aren’t required to carry out the system. It means these smart people don’t have to waste their brainpower trying to figure out the process each time. Instead, they can use their valuable mind to work on the business rather than in the business.
Those familiar with with The E-Myth will recognize the principle of working ON your business rather than IN your business. The author encourages business owners to look at a business like a system. That system needs various roles to be performed to operate smoothly. You start by defining what roles need to be filled and then plug people into those roles. The roles should be so well-defined that they can be performed by almost anyone (within the parameters of certain skills sets).
No role should be completely dependent on a specific person. People should be interchangeable. This may sound cold, but the reality is people come and go. Turnover is always somewhat disruptive, but having well-defined roles and systems will minimize the disruption.
Hopefully I’ve convinced you that you should create systems in all areas of your business, including accounting.
In my next post I will get into more detail about how to create accounting systems specifically.
Question: How have systems helped your business?
Most business owners prefer to focus on building and selling their product or service rather than being bothered with the many mundane details that go along with running a business. I’ve written before about how nothing else matters until a business has a product or service to sell and customers to sell it to. However, many of these mundane details can hinder or even kill a business if not tended to.
Business books (accounting records) are often an afterthought, but having clean books is one of those important details.
I started writing a post about how to keep clean books, but I realized that you won’t care how to keep clean books until you understand why it’s worth your precious attention.
I’ll save the how for next week. For now, I’ll try to convince you of why you should make clean books a priority.
First, what does it mean to have clean books?
Clean can mean different things to different businesses, but in general clean means having accurate, up-to-date, and understandable financial information. You should be able to rely on the financial information in your books to make decisions.
To get specific, for many businesses clean means having accounts receivable (money owed to you) and accounts payable (money you owe) records always up to date. Otherwise, you hurt your cash flow by being slow to invoice customers and follow up on late payments. You hurt vendor relationships by being late on bills.
Clean also means having an accurate income statement and balance sheet soon after the end of each month. Having accurate financial statements usually means bank accounts are reconciled, revenue and expenses are matched in the correct period, inventory is accurate, and depending on the nature of the business, other accounts are up to date.
Now, why should you make clean books a priority?
1. To help you make the best decisions possible
You are never going to have enough information to make a decision. But you can at least make sure you have all the information possible. The primary reason to have clean books is to give yourself as much accurate information as possible for decision making.
Do you have enough cash to invest in that new piece of equipment? How will you know unless you have a current picture of cash in the bank, money owed to you (receivables), and money you owe (payables)? An accurate income statement showing a history of healthy profit can give you confidence that cash will keep coming in.
Often business owners make decisions based on cash in the bank, but cash by itself is not a good indicator of business health.
A high bank balance might give you a false sense of security if you don’t realize that your overdue payables are more than cash available. This problem is common for businesses, such as retail stores, that collect money up front from customers but pay their suppliers on terms.
A low cash balance might keep you up at night, but accurate receivables might show that you would have plenty of cash if could collect overdue balances from customers. A simple collections effort might solve your cash problems.
Clean books will show you really how well your business is doing regardless of cash levels.
2. To help you avoid tax nightmares
You may think it will never happen to you, but government agencies and insurance companies do perform audits. Income tax, sales tax, payroll tax, worker’s compensation and liability insurance, are examples of potential audits.
Many businesses have gone down, bringing the personal lives of the owners with them, for failure to accurately report and pay taxes.
Even if you have nothing to hide, messy books will make audits time-consuming and expensive. Clean books make audits quick and simple.
It’s better to preempt these problems by investing in clean books up front.
3. Books are expensive to clean up, and you will have to clean them up
You will eventually need to clean up your books. It may be forced a government agency. It may be driven by your own desire for better information. It may be required by capital sources, such as banks or investors.
Like many other messes in life, messy books are much less expensive to avoid than to clean up.
Cleaning up books takes a different, and more expensive, skill set than maintaining books.
For a small up-front investment, an experienced accountant can help you set up accounting systems that low-cost bookkeepers or clerks can maintain. Periodic informal reviews by this accountant, such as quarterly or annually, can ensure those systems are operating properly.
In contrast, an experienced accountant will have to do most of the work to clean up your books. The clean-up can’t be done using simple systems that low-cost staff can perform.
I’ll write more in my next post about how to set up systems and people for keeping your books clean.
Keeping clean books is not the most exciting part of running a business (unless your business is an accounting firm). However, clean books will help the more exciting aspects of your business run more smoothly. Clean books can also help you avoid distracting audits and clean-up projects in the future.
Question: Why do you think it’s important to keep your books clean?
In my last post I wrote about how to get started on building a business. My main point was this: until you have a product to sell and customers to buy the product, nothing else matters. Anything else that may intimidate you about running a business doesn’t matter until you start selling a product to a customer.
Offering a product that customers are willing to spend money on is the hard part about running business. Comparatively, the other details are a piece of cake. They should not hold you back from starting a business.
One the most intimidating aspects of starting a business is the fear of failing to meet government requirements. No one wants to get in trouble with the IRS (or equivalent) or other government agencies.
In this post I’ll hopefully put your mind at ease by briefly describing the 3 main ways to keep the government happy as you start your business. The timing depends on the nature and complexity of your business, but in most cases these actions don't matter much until you actually start soliciting sales.
1. Decide on a legal structure
Businesses can operate under several different legal structures. The terminology and details may vary by country, but the main ideas should be the same anywhere in the world. Two of the simplest structures in the United States are sole proprietorship and LLC.
Sole proprietorship. This is the simplest way to get started. You don’t even need to take any action besides accept payment for a product or service. If someone pays you to mow their lawn, you’re a sole proprietor.
The disadvantage of a sole proprietorship is that you are fully liable for all debts and obligations of the business, including actions of employees. Your personal assets are at risk. This may not be a big deal at first, but it’s something to be aware of as you grow.
Limited Liability Companies (LLC). In the US, many small businesses use this structure. LLC's are simple and inexpensive to form (for example, $70 in Utah if you file the one required form yourself), and they provide some liability protection from your business.
2. Complete necessary registrations, licenses, and permits
Once you decide on your legal structure, you need to obtain the necessary government licenses and permits. Typically, your local government will require a business license and your state will require registration to do business (including reserving your business name). Some industries require permits, such as food services.
State and local governments desperately want businesses in their jurisdictions, and they try (as best as governments can) to make it easy for you to start. Why? Among other altruistic reasons, they want to collect more tax revenue!
All state and local governments that I’m aware of have sections on their websites dedicated to doing business in their area. They should outline exactly what you need to do to register your business and meet other legal requirements.
3. Understand your tax obligations
Getting behind on taxes is one of the best ways to get in trouble with governments. They will make your life miserable.
Understanding and keeping up on your tax obligations is not difficult, but it’s incredibly important. I recommend finding a good CPA to do your annual tax return, and this CPA can also advise you on other tax obligations. The details I mention are specific to the United States, but the same principles apply to most countries.
All businesses have to deal with income tax, which I’ll focus on here. Some businesses also have sales tax, property tax, payroll tax, and industry-specific taxes.
Employees don’t have to think much about taxes. Their payroll and estimated income tax is withheld from their paycheck, and after they file their tax returns they pay or get refunded the difference based on their actual tax owed.
In contrast, business owners must pay 1/4 of their estimated annual taxes each quarter (usually 15 days after the end of each quarter). In addition to regular income tax, you must pay self-employment tax (Social Security and Medicare). The 2014 rate was 15.3% (I know - it’s a lot).
Your CPA can help you estimate your quarterly taxes, but a good rule of thumb for many small businesses is 25% of net income (15% for self-employment tax and 10% for income tax). Until you build some history and have a CPA help you with better estimates, I recommend you transfer 25% of your estimated net income into a separate bank account as often as practical.
For example, if you're a freelance programmer with limited expenses, immediately move 25% of every client payment into your savings account.
When it comes time to submit your quarterly estimates to the IRS, you can simply transfer the funds from your savings account rather than scrambling to come up with the money.
I did not intend to make this a detailed guide. You can find more detail on any of these topics from many sources. The SBA, for example, has many great resources, including this section on starting a business.
My goal is to focus you on the most important tasks required to keep the government happy while you get your business going. Hopefully this puts your mind at ease by making government requirements seem less intimidating.
Question: What are other ways to make sure the government is happy as you start a business?
I try to use systems in all areas of my life. Systems automate routine tasks that lead to important outcomes. Systems maximize consistency and minimize time and energy. Systems allow us to focus more on the outcome than the routine tasks that get us there. In business, these systems can take the form of processes. Accounting is a business function particularly conducive to structured processes. The value in accounting comes with the ability to analyze timely and accurate numbers that your processes generate and not in the processes themselves.
Of course, all large business have complex accounting software and processes to make sure their transactions are recorded accurately and their financial statements prepared timely.
I will focus on on 4 ways freelancers and small business owners can automate their accounting:
1. Use checklists
The less you have to think about routine tasks, the more brainpower is freed up for more important activities. Checklists are a great way to minimize the thinking required.
Checklists can be used for any repetitive task, which includes most of the activities a business engages in. Examples include:
- Onboarding a new employee
- Setting up a new vendor
- Setting up a new customer
- Closing the store or restaurant at night
- Preparing an order for shipment
Checklists are especially helpful in nailing the month-end end accounting close, which brings me to my next point…
2. Nail your month-end close
"Month-end close” or the “financial statement close process” might sound like a complicated activity that only big companies worry about, but it simply refers to the activities that provide accurate financials after the end of a month.
The sooner you can get financial statements after the end of the month, and the more accurate those financials are, the better decisions you will be able to make.
This process should be so well defined and refined that it’s automatic. It doesn’t mean smart and skilled people aren’t required to carry out the system, but it means these people don’t have to figure out the process every month. Instead, they can use their valuable time and brainpower to analyze the financials and identify areas for improving the business.
Checklists in a Google Sheet have worked well for me. A tab lists all the tasks required to close out month end, when each task needs to be done, and who is responsible for each. Those responsible sign off on each task, giving me a real-time status.
Setting up bank feeds helps to automate month end. Most accounting software packages, such as Xero and Quickbooks Online, connect directly to bank accounts and credit cards and download new transactions every day. Bookkeepers only have to assign the correct account code to each transaction before reconciling the account.
Software that doesn’t support bank feeds should at least support transaction import, which allows you to download the transactions from your bank account and import the downloaded file into your accounting software.
3. Use dashboards and scheduled reports
It’s good to review a full set of financial statements monthly, but you’ll often need information sooner to make decisions. While it’s not practical to perform the full accounting process more than monthly, important transactions such as sales should be recorded in real time.
As a business owner, you should have access to as much real-time information as possible. Some accounting software will email you reports on a set schedule. For example, for one company I get a daily automated email with customer payments received, new orders received, and orders shipped. This allows me to keep a daily pulse on the business.
4. Outsource your bookkeeping
It doesn’t make sense for many freelancers and small businesses to hire full-time bookkeepers. In some small businesses, employees wear multiple hats, and the office manager, for example, may double as a bookkeeper. This may work out okay if you have team members with sufficient time and are comfortable with bookkeeping.
However, in most cases it’s better to outsource your bookkeeping. This allows you to hire for specific skills needed to add value to your business. You can outsource to accounting firms, but this is often quite expensive. I recommend finding offshore bookkeepers though a service like Elance.
All of the companies I work with have used offshore bookkeepers for several years, and it works great. We pay between $6 and $12 per hour, depending on the complexity, and the bookkeepers are accurate and dependable. For example, we forward any invoices we receive, and they do the accounting software entry and file the digital copy. They also complete most of the month-end checklist.
Automate Your Business
Accounting is an obvious candidate for automation, but you can automate any area of your business. It can help to recognize anything that is done on a regular basis and think about how it can be automated.
Question: What other tips do you have for automating accounting?
When running a business, the type of legal entity you choose is a complex and important decision. I recently had to research what type of LLC to set up for a married solo practitioner, or freelancer. I thought I would write about what I have learned to help my thought process and to hopefully help someone else facing a similar decision.
If this post doesn’t apply to you or anyone you advise, you can check out some of my past posts that might be more relevant by using the topic buttons (computer) or menu (mobile device) above.
LLC vs. Sole Proprietorship
Freelancers who have a full-time job but pick up work on the side will probably start out operating as a sole proprietorship. In fact, you don’t have to do anything but earn extra income to operate as a sole proprietorship. The income becomes part of your business activities, which you report on Schedule C of your personal tax return.
The benefit is that setting it up doesn’t require anything more than any licenses and permits required to operate the business, which probably doesn’t apply to most freelance work.
The down side is there is no legal separation between you and your business, which makes you personally liable for debts, lawsuits, and actions of employees. This puts your personal assets at risk.
An LLC is a legal entity separate from its owners, or members, so the owners aren’t personally liable for the business (with some exceptions). LLC’s are easy and inexpensive to set up and maintain. The filing fee for the LLC I set up in Utah was $70. The only maintenance needs are tax and regulatory requirements, which you’d have to do for a sole proprietorship anyway, and a $15 annual renewal fee.
If your business is anything more than small side jobs here and there, it is usually wise to set up an LLC. Search online for “how to set up an LLC in [your state]” and you’ll find many resources with step-by-step instructions. For example, see here for Utah instructions.
Types of LLCs
Once you’ve decided to set up an LLC, you’ll have to decide how it’s structured for tax purposes. There are several variations, and each state may differ slightly, but the following are 3 types of LLCs I considered:
1. Single-member LLC (Disregarded entity) As indicated by the name, a single-member LLC is owned by one person. The owner can either file Form 1040 Schedule C like a sole proprietor (become a disregarded entity) or elect to be taxed as a corporation.
There are some disadvantages when compared to a multi-member LLC, including: - Some risk of losing the LLC personal liability protection benefit in the event of a lawsuit or audit. Courts may not recognize the person as being separate from the entity. - Possible increased risk of an IRS audit because sole proprietorships are audited more frequently than partnerships or corporations.
This article talks about these and other disadvantages.
One advantage of a single-member LLC is that it qualifies for a Health Reimbursement Arrangement (HRA) if one spouse is the owner and the other spouse is an employee. This is a program administered by a 3rd party that allows your LLC to reimburse 100% of out-of-pocket health expenses and individual health insurance premiums. The HRA is the only way I’m aware of to make individual health insurance premiums fully tax deductible. Multi-member LLC’s do not quality for an HRA.
You can read more about HRAs here.
2. Multi-member LLC (Partnership) Multi-member LLCs, obviously, are owned by more than one person and can be elected to be taxed like a partnership or a corporation. As a partnership, the LLC must file Form 1065 and provide each member with a Schedule K-1 showing their share of the LLC income, credits and deductions.
A multi-member LLC overcomes the disadvantages of a single-member LLC described above. Married couples can create a multi-member LLC by each owning a share of the company.
LLC members active in the business must pay self-employment tax on their entire share of the profits. Married couples are always both considered active members, even if one is not active in the business. The maximum earnings limit ($118,500 in 2014) applies to each spouse. If the profits are more than the maximum, and if you want to minimize this tax, you might want to assign one spouse a very small percentage.
This article goes into detail about single-member vs. multi-member LLC’s for married people.
3. LLC as an S-Corp An LLC can elected to be treated like an S Corp. This is an interesting way to minimize self-employment tax. The members don’t have to pay self-employment tax on their share of the profits, but active members (again, both spouses) must be paid reasonable compensation subject to self-employment tax.
There is much more to choosing a business entity than I have covered here, but hopefully my research on LLC’s helps familiarize yourself with the options available. Understanding the basics will allow you feel more confident in working with a professional advisor to make a final decision.
Note: I am not an attorney, and although I’m a CPA, I am not a tax accountant, so don’t take this as professional advice. I have provided this material for informational purposes only, and I encourage you to seek competent tax and legal counsel.
I work with a venture capital fund and several startups, and I have had to learn a completely new industry with every new project. I am involved with building materials, telecommunications infrastructure, clean energy, and mattresses, to name a few. Lately I have been working especially hard at learning the venture capital industry. As part of this effort, I am in the process of reading The Business of Venture Capital by Mahendra Ramsinghani. It is an excellent, comprehensive look at all aspects of venture capital. This got me thinking about the approach I have taken to learning a new industry as quickly as possible.
Many people spend a lifetime learning a particular industry. However, it’s common to change career direction many times. While nothing can replace many years of hands-on experience, it’s possible to accelerate the learning process.
Here are some tips and tricks for scaling the learning curve in a new industry:
1. Read books Books are a powerful way to acquire new knowledge and insert yourself into new experiences. Of course, reading is not a perfect substitute for actually being there, but being there takes time, opportunity, and luck.
In a previous post I talk about my experience listening via audio book to 4 incredible stories about the founding or turnaround of Twitter, Facebook, Blackstone Capital, and Ford. For $44 and two weeks while doing things I had to do anyway, I experienced 50 years of building or turning around 4 multi-billion-dollar companies.
2. Follow trade publications Every industry has trade publications, and they are great ways to learn and stay current on new developments.
The mattress industry was new to me, and I work with industry veterans with 20-30 years of experience. Even though I can’t match their years of experience, I have become familiar with the industry by regularly reading the two main trade publications, Furniture Today and Bedtimes.
3. Attend conferences and trade shows Gatherings like this can be challenging to navigate, especially for an introvert like me. But every industry has conferences and trade show where the who’s who of the industry gather in one place. At these events you can learn from speakers, panel discussions, and product/service booths.
Building your network of contacts is just as important as learning an industry, and conferences are an efficient way to build your network.
Attending the semi-annual Las Vegas Market for the home products industry has accelerated my industry knowledge and contacts.
4. Participate in networking events Most industries have local get-togethers for networking and learning.
I recently attended a networking event in Salt Lake City that I found very valuable. It was organized and attended by professionals in similar industries and career stage. The organizers invited a high-profile speaker a few years ahead of us in experience and success. We were able to build our contacts with each other and learn from the speaker's experience.
You can find networking events through Internet searches or LinkedIn, for example. If you can’t find relevant networking events, organize one yourself! There’s no better way to get to know people and build credibility in an industry than to be a leader.
5. Visit the front lines It’s great to gain experience in the board room or in executive meetings, but the real work happens on the front lines: stores, call centers, factories, etc. It’s impossible to understand an industry without understanding the front lines.
When I first became the CFO of a building products manufacturer, I spent a lot of time working alongside the production team in the factory. This was challenging, but it was the fastest way to learn the processes and get to know the team. Being on the floor gave me the understanding I needed to made process improvements that cut labor costs in half.
The speaker at the Salt Lake City networking event I mentioned talked about the turnaround he led of a local company. I was with a colleague, and we happened to be driving by this business on the way to our next meeting. We stopped in and talked to one of the front-line employees who was there during the turnaround a few years ago.
We learned a lot as he told us about his experience, including the methods used to drive the turnaround. It was most instructive to hear the gratitude and respect in this employee’s voice as he spoke of that experience.
Go and learn! There’s no reason to be afraid of learning a new industry. Of course, it’s difficult to replace years of experience in a short amount of time, but you can use these tips and tricks to dive into a new industry and become a veteran in a short time.
Question: What approach have you taken to learning a new industry?
I am taking a class from the Stanford Graduate School of Business right now. But no, I haven’t had to travel to Palo Alto or pay thousands of dollars in tuition. Thanks to the MOOC concept (massive online open course), I am able to take the class for free from the comfort of my own home. The class is Scaling Up Your Venture Without Screwing Up taught by well-known professors Huggy Rao and Robert Sutton. The class follows the book written by the professors, Scaling Up Excellence, and is supplemented by short video lectures, video interviews with entrepreneurs who have successfully scaled companies (such as Ben Horowitz), and individual and team assignments.
I am taking this course because of my involvement with a venture capital fund and venture-backed companies. The goal of any venture-backed company is to scale as quickly as possible.
The class material has caused me to reflect on my own experiences in trying to scale startups over the last few years. I’ll share 3 lessons I’ve learned from my experience:
1. Interpret data correctly It is impossible to gather enough information for making a perfect decision in any business, and startups are especially uncertain. We have to make the best decisions possible given the data available. Due to the difficulty of gathering data, it is extremely important to interpret the available data correctly.
I learned this lesson the hard way a few years ago with a company that manufactured product in the US and sold in both US and Canada. With the downturn in 2007, sales in the US dropped by 90% while Canada sales continued to grow. The US dollar also weakened significantly and became worth less than the Canadian dollar, which helped margins in Canada.
We started to put our focus on Canadian sales while waiting for the US to recover. However, in late 2008 and through 2009, the Canadian dollar reversed course and weakened 20-25% against the US dollar. This significantly cut into our margins. I looked at the data and found that even after the drop in US prices with the downturn, our percent margin was now higher in the US.
As a result, we turned our focus to the US. We hired a sales team and even opened a retail store. Unfortunately, our efforts didn’t lead to the boost in sales we hoped. Even more unfortunately, I realized later that even though our percent margin was higher in the US, our dollar margin was still higher in Canada due to higher prices.
Of course, we couldn’t have predicted exchange rates, but by late 2009 the US and Canadian dollars returned to about par. Due to my misinterpretation of the data, we wasted a lot of money trying to boost US sales while losing a year during which we could have doubled down on the stronger Canadian market.
2. Hire only to alleviate pain, not for pleasure I learned this lesson from experience and found it articulated well by 37Signals (now Basecamp) co-founder Jason Fried. "First, we hire late. We hire after it hurts. We hire to alleviate pain, not for pleasure. Who hires for pleasure? Any company that hires people before it needs them is hiring for pleasure. It's an indulgence we've never allowed ourselves.”
I’ve been involved in decisions several times where someone was hired too early, too fast, or just because they’re a good person who we didn’t want to lose.
3. Give ground grudgingly This is another lesson I’ve learned from experience but found articulated brilliantly by someone else. Ben Horowitz wrote a blog post called Taking the Mystery out of Scaling a Company. In it, he compares scaling a company to an offensive lineman in American Football. While in pass protection, the offensive lineman can’t protect the the quarterback by standing his ground or moving forward, or the defensive lineman will get around him. His goal is to back up as slowly as possible, hoping to give the quarterback enough time to throw the ball.
As a team grows, it becomes necessary to put in place processes and procedures that facilitate communication, knowledge transfer, and decision making. This is necessary to run the company smoothly, but it also creates bureaucracy and complexity in the organization. The principle is to give ground grudgingly. Only add processes and procedures as they become necessary.
I joined a very small team a few years ago. I had some experience in a big company, and I thought the small company would be successful if it acted like a big company. I worked with the CEO to define the organizational structure and associated roles. We put written procedures in place for all business processes. We even started annual performance reviews. All of this was for a company with less than 10 employees.
Our intent was good. We were trying to follow the E-Myth principle by working on the business and preparing for growth. But we spent unnecessary time creating unnecessary complexity. We should have waited until growth made this steps necessary.
Scaling a company is messy. Often the answers can only be found through trial and error. But some errors can be avoided by following general principles learned from others experiences.
Entrepreneurs focus on identifying problems to solve, building solutions to those problems, and selling those solutions. Most entrepreneurs don’t want to be bothered by distractions from this core focus. There are plenty of necessary distractions in business, such as bookkeeping, taxes, and HR paperwork. Part of the CFO’s job is to make sure the details are handled so you, the entrepreneur, can focus on what you do best. But how do you know if your CFO is doing his job? Here are six things your CFO should do for you:
1. Keep you out of trouble
Your CFO might not be able to keep you out of trouble in every way, but she should at least keep you in favor with governments. Government regulations include tax filings, HR paperwork, business licenses and permits, environmental, and industry-specific regulations. Penalties can be severe, and governments usually aren’t very forgiving of mistakes.
The CFO should make sure all tax filings are done accurately and on time. Tax filings include payroll tax, sales tax, income tax, property tax, and other industry- and location-specific taxes. Most filings are routine and can be done by clerical staff, but the CFO should set up and monitor the systems that make sure it gets done.
Make sure your CFO doesn’t use late tax payments as a cash flow strategy. This is never a good idea. The IRS or your country’s tax agency will destroy you. I once helped a company that had been using late payroll tax payments to help cash flow. It took over a year to clean up the mess, and the penalties, interest, and liens almost took down the company.
2. Give you clean monthly financials
You must have accurate and complete financials to make good decisions, and you need them soon after month end. Your CFO probably doesn’t do the bookkeeping, but he should design and oversee business processes that allow for immediate recording of transactions followed by an efficient month-end close process.
3. Identify, monitor, and interpret key metrics
Your CFO should provide you with monthly financials, but the financials don’t usually provide all the information you need to make good decisions. Plus, monthly is not often enough for some metrics.
Soon after joining one company, I identified manufacturing labor cost as the single most important cost to focus on. All other expenses were fixed or varied within a small range, but labor cost could vary wildly day to day due to the manual nature of the process. We set up a system to report estimated cost daily and exact cost each pay period. We found that our labor cost was double the industry benchmark. Using this data we made adjustments that cut labor cost in half.
The most important variables for a retailer I work with are daily sales revenue and gross margin. Our accounting system automatically emails a report each evening to the CEO that shows each item sold that day and the average selling price. That, combined with a more detailed monthly review of average margins by product line, allows the CEO to make adjustments quickly if the metrics get out of line.
4. Match your business to the right technology
In many businesses the CFO is responsible for technology. At a minimum, she should be tech-savvy enough to choose and use the best accounting systems for your business.
Many businesses use Quickbooks because it’s cheap, easy, and familiar. However, there are many drawbacks to using Quickbooks, such as keeping track of and backing up a data file, difficult remote access, and poor inventory management (and therefore poor gross margin tracking). Quickbooks may be right for you, but your CFO should be familiar with other options. I recommend Xero or Netsuite for many businesses because they are easy to use and are hosted online. (Read my Netsuite and Xero reviews on TrustRadius).
The primary reason I landed one client was my experience with software. They wanted to implement a sales management software system, integrate it with the accounting system, and train people to use the software. Rather than pay for a specialized consultant to run this project, I was able to take on this project in addition to regular CFO roles. Not only did this save the company money, but they also had someone in-house who was familiar with the software and how it fits into the accounting processes.
5. Help you make good decisions
A CFO should be more than just a bean counter. She should be a strategic partner that helps you make good decisions. She should combine her deep understanding of the numbers with a deep understanding of the business, the industry, and the economic environment it operates in. The CFO should be involved in and be a valuable contributor to all major decisions.
I helped the CEO of a commodity product manufacturer evaluate their business model. By reviewing the data we realized they didn’t have the scale or differentiation to compete against much larger competitors. Rather than expanding manufacturing as planned, they added product lines from other manufacturers to their distribution channels, which had led to rapid growth.
6. Prepare for growth
As an entrepreneur, your motivation is probably to make an impact on the world while getting a good return on the time and money you put into the business. Having the greatest possible impact and the greatest possible return usually means growing the business as fast as possible. Most startups are chaotic, which is okay as they build their product, feel out the market, and make adjustments.
But when they start seeing traction, they need to be prepared for growth. The entrepreneur usually drives the growth, but the CFO can make growth possible by putting efficient processes and procedures in place. Timing is critical, and it takes an experienced CFO to get this timing right. You don’t want to add unnecessary cost and complexity before the business needs it, but you need to be prepared for growth.
You must have a good CFO at your right hand if you want to build a successful business. A good CFO can free you from the details and help you make good decisions. A bad CFO can destroy your business by getting you in trouble or giving you bad information for making decisions. Given the importance of the CFO role, it’s important that you understand what your CFO should be doing for you.
Question: Are there important CFO roles I am missing?
See my other CFO-related posts here.
One of the most common reasons for business failure is running out of cash. This may seem obvious, but even profitable companies go bankrupt because they don’t have the cash to fund their growth. Everyone understands that a business’ revenue must exceed its expenses to survive long term (or at least it must have a feasible plan to get there with investment capital).
However, profitability alone is not enough. Manufacturers need cash to purchase raw materials and pay their overhead expenses before they ship to and collect from customers. Retailers need to purchase inventory before customers visit.
As the CFO of several startup companies, one of my top priorities is cash flow planning. The following are four things I have learned about managing business cash flow:
1. Religiously maintain short-, medium-, and long-term cash flow projections
The tighter your cash flow, the more time you’ll need to spend on projections. Cash flow is tight in all of the companies I work with. I usually spend at least some time every day updating short-term projections, every week updating medium-term projections, and every month updating long-term projections.
Long-term typically means 1 to 5 years. Cash flow projections are built into the financial models I use for generating pro forma financial statements. The models take into account budgeted profit or loss, working capital needs, capital investments or sale of assets, and expected financing to be received or repaid (notice this follows the sections of the cash flow statement). Information about projected cash excess or shortfall can be used in strategic planning decisions.
Medium-term usually means 1 to 12 months. The process is similar to long-term planning but more detailed to make sure we can handle temporary dips.
Short-term means within the next month. This is where we get very detailed. Medium- and long-term plans have to make assumptions about expected receivables, inventory, and payables balances, for example. But within the next month we need to know what invoices we expect to collect, when inventory purchases will be made, and what bills need to be paid (especially payroll!).
Diligence in this area is incredibly important. It takes time to make adjustments for cash shortfalls, such as by raising money, selling assets, or cutting costs.
2. Overestimate your needs
You’ve probably heard the following business advice: figure out what cash you think you’ll need, double it, and then double it again. In most cases, businesses take a lot more time and money to build than we expect. Especially when planning for long-term cash flow, err on the high side.
If you need cash to grow and are raising money from investors, raise much more that you think you’ll need. A little extra dilution is better than running out of cash.
3. Build an emergency fund
This is related to point 2. Hold an emergency (or reserve) fund that is double or quadruple the size you think you’ll need. It is standard advice in personal finance to have savings equal to between three and six months of expenses. I think a business emergency fund should be even higher to allow it to weather downturns and take advantage of good deals.
If your business doesn’t have an emergency fund, build one a little bit at a time. Your survival could depend on it.
Bill Gates wasn’t comfortable with Microsoft’s cash flow until he had a year’s worth of payroll in the bank. As a software only company at the time, most of Microsoft’s expense was payroll.
Despite their best efforts to manage cash flow, many businesses have times when they simply can’t pay all the bills on time. In this case, it is important to prioritize wisely.
I again draw a parallel to personal finance. Dave Ramsey talks about taking care of the necessities of life first - food, clothing, shelter, and transportation. You wouldn’t allow your electricity to be shut off or your children to starve while you pay your credit card bill. Your credit card company may not be happy, but there’s not a lot they can do while you meet your needs in the short term.
A business is similar. First focus on bills that allow your business to keep operating. You won’t be able to pay anyone if your business fails. Payroll is usually at the top of the list. Most vendors will have some level of patience with late payments. You don’t want to risk losing credit terms, which will hurt future cash flow. But as you build relationships with your vendors you will find that some will be more patient and understanding than others.
Cash is King. Paying careful attention to cash flow is just as important to a company’s survival as building and selling a great product.
Question: What tips and tricks do you have for managing cash flow?