Why Your Business Should Invest in Clean Books

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? 

3 Important Details When Starting a Business

In a previous post  I wrote about how to get started on building a business. My main point was this: nothing else matters until you have a product to sell and customers to sell to. In my last post I wrote about how to stay on the government’s good side as you start selling your product.

In this post I’ll briefly describe the 3 other important details to take care of as you start a business. The timing depends on the nature and complexity of your business, but most of these details don't matter much until you actually start selling a product.

1. Set up business bank accounts

This is a must! Your bookkeeping will be a nightmare if you pay expenses from and receive payments into your personal bank account. This is called co-mingling funds, and it’s never a good idea.

Co-mingling funds will make it difficult to figure out how much money your business is making, and your tax return will be difficult to prepare after the end of the year.

Setting up a business bank account is easy, and your bank will tell you what documents they require.

I recommend setting up both checking and savings accounts. The savings account is where you regularly transfer estimated taxes so you’re not tempted to use the funds elsewhere.

2. Set up an accounting system

An accounting system is a way of tracking revenue coming in and expenses going out. As often as is helpful, and at least monthly, you need to look carefully at your net income (revenue minus expenses).

An accounting system does not have to be complicated. For simple businesses, an Excel spreadsheet or even a notebook might be sufficient.

However, I recommend online accounting software for most businesses. Software like FreshBooks, Xero, and Quickbooks Online are inexpensive and easy for non-accountants to use. They will connect to your bank account and automatically download transactions. You can also enter your vendor bills and payments to keep track of what you owe (payables) and invoice customers and record payments to keep track of what you are owed (receivables). You can run reports to track your business performance.

Setting up an accounting system and keeping it up to date daily or weekly is easy. Trying to do all your bookkeeping for the year at tax time is not so easy (and doesn’t give you critical information you need to make good business decisions).

3. Make sure you are adequately insured

In your personal life, you should carry several types of insurance: life, homeowner/renter, health, and auto for example.

Your business life adds additional insurance requirements. Needs vary by business type, but here are some possibilities to get you thinking:

Auto. Obviously a vehicle owned by your business needs to be insured, but check with your auto insurance provider if you use your personal vehicle for your business. You may need to adjust your policy.

Property. If you rent space for your business, you’ll need tenant insurance for liability and belongings. If you work out of your home, check with your home insurance provider to see if that affects your policy.

General and product liability. These are often bundled into the same policy, but make sure you have both. General liability insurance covers a wide range of potential claims against your business. Product liability is important because anyone who sells a product can be liable for defects, even resellers.

Professional liability. This is also known as errors and omissions insurance and is applicable to some professions, such as accountants, attorneys, doctors, and financial advisors.

This is just a sampling of the common types of business insurance. You should do some research to make sure you are adequately covered, and an insurance broker would be happy to help as well. This page on the SBA website is a good place to start.

Final thoughts

My goal is to focus you on the most important tasks required to get a business going (besides products and customers). Hopefully this puts your mind at ease by making the administrative requirements seem less intimidating.

Question: What are other important details to address when starting a business? 

4 Ways to Automate Your Accounting

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? 

4 Ways to Prevent Personal Finance from Hurting Your Business

Successful entrepreneurs want to pour everything they have into their businesses, including time, attention, energy, and money. 100% commitment increases the odds of success in an area with high risk of failure. However, 100% commitment doesn’t necessarily mean giving everything you have. Giving too much in one area may prevent you from giving enough in more important areas. This principle applies to various aspects of life, but I will address the financial.

It’s obvious that your business performance impacts your personal financial situation. But it’s not as obvious that your personal financial situation also impacts the success of your business.

Sometimes pouring all of your money into a venture prevents you from giving something more valuable: your undivided attention. Personal financial struggles create stress, which distracts your attention from your business.

Here are four ways to avoid distracting personal financial struggles. Although I’m addressing entrepreneurs specifically, these principles apply to anyone.

1. Keep your overhead low

Keeping overhead low is a business principle that also applies to personal finance. Overhead is a company's fixed, ongoing expenses, which could include rent, utilities, travel, and debt payments.

Successful businesses keep their overhead as low as possible. The lower the overhead, the faster a startup can get to the critical breakeven milestone. The lower the overhead, the more prepared a profitable business can respond to fluctuations in revenue or investment opportunities.

Similarly, low personal overhead means you don’t need to generate much personal income to cover your basic expenses. You know you can quickly adapt to changing circumstances, such business cash flow struggles. The resulting peace of mind allows you to focus on your business.

One way to keep overhead low is to avoid debt, especially when used to purchase depreciating assets. Getting a loan to buy a vehicle, RV, or furniture set commits you to paying for it over time, no matter what happens to your finances. These types of purchases usually drop in value faster than the loan is paid down, which means you can’t simply sell the asset to pay off the loan if you don’t want the payments anymore.

Besides, debt payments get in the way of savings money for emergencies and investing, which are covered in the next two points.

2. Set aside at least six months of expenses (and don’t touch it even in an emergency)

Having at least six months of expenses in savings, while also having low personal overhead, provides even greater peace of mind. You will make better decisions for your business knowing that you don’t have to consistently take money out of the business to live on.

Consider this stash sacred. I’m being facetious when I say not to touch it even in an emergency, but something close to that should be your mindset. It’s not vacation or nicer car or home renovation money. It’s there to help you weather the ups and downs of your business.

Most startups hit rough patches, and being able to go a few months without taking money out might make the difference between success and failure. You will also be less dependent on outside capital. Taking on debt increases your business risk, and the payments add to overhead (see point 1). Giving up equity dilutes your ownership and control.

3. Develop an investment strategy separate from your business 

Entrepreneurs, by nature and necessity, are eternal optimists about their business. You know you will succeed and want to pour everything you have into it. You wonder why you should invest anywhere else when you can invest in your own business.

But what if your business doesn’t succeed? What are you left with?

No matter how confident you are in your business, you must diversify. We all know we shouldn't have all of our eggs in one basket. No matter how attractive that basket looks right now, unforeseen circumstances can quickly crush all of the eggs.

I suggest consistently investing 10-20% of your personal income somewhere other than your business. If you take just enough out of your business to live on, take out 10-20% more to invest.

You’re likely spending every waking hour building your business, so you’re not going to have much time to research other investment opportunities. The good news is you don’t need to. For most people, investing in low-cost index funds is the way to go.

If you can break away from your business to read, I recommend Tony Robbins new book, MONEY Master the Game: 7 Simple Steps to Financial Freedom. I just finished reading it, and it provides unbiased advice for minimizing fees and risk while maximizing returns, all while spending very little time.

4. Take money off the table when given the chance

At some point you may have the opportunity to sell all or part of your business. What to do in this situation is an intensely personal decision with numerous factors.

I can’t suggest what to do in every situation, but it’s often a good idea to take money off the table when given the chance. This is especially true if you’re not well diversified in other investments.

Taking money off the table doesn’t necessarily mean giving up your business. You could sell shares to a trusted partner or spin off part of your business.

In another post I wrote about creating value vs capturing value. Entrepreneurs like to create value, but there comes a time when that value should be captured.

Hold back for success 

You will be most successful by putting almost everything you have into your business. By carefully choosing what to hold back, you increase the likelihood of achieving your goals.

Making smart personal financial decisions will give you peace of mind, which will allow you to give undivided attention to your business.

Question: What personal financial strategies have allowed you to focus on your business?

Should Sales or Accounting Handle Collections?

I’ve worked with startups for several years. I’ve had a lot of experience with both the giving and receiving end of collections efforts. In my role as CFO, I’ve seen what brings in our receivables most effectively and what tactics best encourage us to prioritize vendors when cash is tight.

Collecting bills is a balancing act. You must keep cash flowing to pay your own bills, but helping customers through difficult times can build loyalty. It’s important to have an effective strategy for finding the right balance.

An important part of the strategy is defining who contacts customers whose bills are overdue. A common debate is whether sales or accounting should take this role.

Before I share my preference, here are some of the arguments for either side:

Reasons for accounting to handle collections: 

1. Sales should focus their time and attention on selling and not administrative tasks.

2. Hounding customers for payment might hurt the customer relationship.

Reasons for sales to handle collections: 

1. Sales can use their relationship to encourage payment. Faceless accounting people are easy to ignore.

2. Knowing the customers' account status and payment habits helps sales understand the customer better.

3. Sales will be more motivated to sell to credit-worthy customers if they know they also have to collect.

You can probably guess my preference from the length of my arguments. In businesses that have sales reps with direct customer relationships, I strongly prefer that the sales reps make the collections calls.

This preference comes mainly from my experience from the customer side. As I wrote about in a previous post, the startups I work with sometimes don't have enough cash to go around.

Prioritizing precious cash is difficult when I desperately want to pay everyone on time. Often my decisions about who to pay and when are based on relationships. It's easy to ignore an email or voicemail from an accounts receivable person I don't know. It's difficult to ignore a sales rep whose relationship and service I value.

Yes, there is a risk that pushing customers for payment will damage the relationship. But customers understand they need to pay their bills on time. If they're offended when asked nicely to pay, they aren't the kind of customer you want anyway.

Yes, collections takes time that a salesperson could be using to generate more sales. But they should be in regular contact and familiar with the customer anyway. Mentioning a late bill shouldn't take much extra time.

Here are some tips for salespeople who want to collect effectively:

1. Set expectations from the beginning. When onboarding a new customer, make it clear that you expect them to pay their bills on time or they will hear from you.

2. Follow up promptly. After telling them they will hear from you if they get behind, follow through. The contact doesn't have to be threatening. The day after a bill is due, give them a friendly reminder. Sometimes late payments are simply the result of a misplaced invoice.

3. Be patient and understanding. For honest business people, not being able to pay the bills is stressful. You can make it clear you expect to get paid while empathizing with their situation. Helping a good customer through difficult times goes a long way toward build lasting loyalty.

4. Blame accounting! And it will be the truth. Accounting and management set the collections policies, and as a salesperson you are just doing your job.

I encourage you to at least consider giving sales the responsibility for collections. Let the salespeople leverage their relationships to keep the cash flowing.

Question: In your business does sales or accounting handle collections, and why? 

5 Reasons to Consider Xero for your Accounting Software

I’m a huge fan of Xero online accounting software. I started using Xero for two companies in 2010, four years after Xero was founded (you can read more about their history here). I now use Xero for seven companies in the US and Canada.

Before adopting Xero, I had been using the Quickbooks desktop version. I was sick of managing data files, sharing with multiple users over a network, and maintaining the IT needed for remote access. I chose Xero after researching online / cloud / Software as a Service (SaaS) accounting software.

I would have been happy to move to Quickbooks Online, but it contained only a portion of the desktop version’s features, and there was no way to directly convert a Canadian data file to Quickbooks Online. In a classic case of Innovator’s Dilemma, Intuit (maker of Quickbooks) has missed out on the rapid rise of the SaaS model.

I realize that no software is one size fits all, but I think every startup and small- to medium-size business should at least consider Xero for their accounting software for the following five reasons:

1. Xero is Software as a Service (SaaS)

SaaS software simply means that the software is hosted on servers somewhere in the world (in the “cloud”), and you can access the software through a Web browser or mobile app. You don’t have to manage software installations or data on your own equipment.

I was on the Salesforce.com audit team while working for Ernst & Young in 2006. That experience indoctrinated me into Salesforce.com’s “No Software” mindset even before SaaS was cool. I use cloud software for everything except Microsoft Word and Excel, and even then I prefer to use Google Documents and Sheets whenever possible.

I wrote two blog posts on this topic here and here.

2. Xero is well-funded and rapidly improving

Xero does have some drawbacks. It offers a limited number of standard reports, and reports can’t be customized beyond grouping accounts. The Global version doesn’t have check printing capability (the US version does). You can't batch pay invoices that aren't in the functional currency, which takes extra work to reconcile separate payments in Xero with one payment in the bank account.

However, over the last 4 years, the product has rapidly improved, and I am confident that the drawbacks will be addressed soon. The company has raised over $230 million and are putting those funds to work with product improvements. For example, I understand that significant reporting improvements are coming soon.

3. Xero is simple to use

Accountants familiar with any other accounting software can quickly become proficient in Xero. You don’t even need to be an accountant to use it. The menus and processes are intuitive, and help links are context-sensitive.

In many cases Xero replaces standard accounting lingo with more layman’s terms. Instead of accounts receivable, it’s sales. Instead of accounts payable, it’s purchases. Instead of post expenses, it’s spend money.

4. Setup is quick and easy

You can be up and running with a new company within minutes by running through a simple setup wizard. Uploading logos and customizing invoice templates is easy. The default chart of accounts is a good start for most businesses, and editing is simple.

Converting from one accounting system to another is usually challenging, but Xero minimizes the pain with good import tools. They even have a free tool to convert a US Quickbooks file directly to Xero.

A few months ago I converted a company mid-year from Microsoft Dynamics GP to Xero. It took some work to reconcile the ending balances in GP with the opening balances in Xero. Most of the work was getting the data out of GP. Importing opening balances into Xero was easy.

5. Xero has a large Add-on Marketplace

Xero doesn’t try to be all things to all companies. It’s not an all-in-one solution like Netsuite or SAP. It handles sales, purchases, bank accounts, fixed assets, and payroll very well. For other business functions, it integrates well with a large number of add-ons built by development partners.

For example, Xero doesn’t handle inventory and cost of goods sold. One company I work with is a manufacturer and distributor of physical products. We use Unleashed Software for warehousing/manufacturing, and it integrates with Xero to communicate the financial information.

Give Xero a Try

In summary, I highly recommend you at least consider Xero for your startup and small- to medium-size business.

It may not be worth the switching cost for companies already using different accounting software, but I think it’s a no-brainer for many startups. You can always convert to a larger (and more expensive) system when you’re on your way to becoming a billion-dollar company.

By the way, I reviewed Xero on TrustRadius, which you can read here.

 Question: What has been your experience using Xero been like? 

4 Dangers of Raising Money

Every startup needs some money to get going. Often founders start with their own funds and then turn to outside sources when they need more. Outside sources may include banks and credit cards, friends and family, angel investors, and venture capital firms. Entrepreneurs are often so enthusiastic about and confident in their startup that they believe money will solve all their problems. However, they should beware of these 4 dangers of raising money.

1. Dilution

Dilution means the founders own less of the company. For example, two founders may own 50% each until an angel investor takes 10% in return for an investment. Now the founders only own 45%. This may not seem like a big deal, but most companies need additional rounds of investment. Each round will reduce the founders’ ownership.

A venture capital firm might take 20% of the company for the next round, which means the founders own 36% each, and the angel investor owns 8%. Founders can be left with a tiny percentage of the company after several investment rounds.

Dilution isn’t necessarily a bad thing. A small piece of a huge pie may be better than a big piece of a tiny pie. The trick is to make sure the investment grows the pie and doesn’t continue to divide the small pie.

2. Loss of Control

Loss of control is related to dilution. In theory, each owner has influence over the company in proportion to their ownership stake. In practice, owners elect a board of directors to represent their interests. When founders start a company, they have complete control. Each new investment gives someone else input into company decisions.

Some investors will require more control than their ownership stake would normally allow. For example, venture capital funds that own a minority share in the company might have a guaranteed seat on the board of directors and veto power over certain decisions.

As with dilution, lack of control isn’t always a bad thing. Investors can (and should) use their influence, experience, and contacts to help the company succeed. The trick is to find “smart money,” or money from investors who can actually help the company succeed.

3. False sense of security

Some teams believe that money will solve all their problems. They celebrate the closing of an investment round as if they have made it.

The truth is that money doesn’t solve problems. An associate of mine often says, “if money will solve the problem, it’s not a real problem.”  It might simply give the team more time and resources to throw at the problem, but it doesn’t solve the problem.

Instead, teams should celebrate the revenue and profit growth enabled by the investment.

4. Acceleration in the wrong direction

Investment is to companies what rocket fuel is to spaceships. Engineers and astronauts spend months or even years preparing for a visit to space. They make sure all their plans are solid, and then adding fuel is one of the last steps in the process. The fuel enables the acceleration to the destination that they have prepared for.

What if the engineers don’t know what their destination is? Or what if they know where they want to go, but they don’t know the route to get there? The rocket fuel still has the same amount of power, but it won’t send them to where they want to go.

Entrepreneurs should know what direction they want to go before taking outside money.

The Antidote - Lean Thinking

One of the antidotes to the dangers of fundraising is lean thinking, which I wrote about here. Eric Ries also writes about lean principles in his book, The Lean Startup. Companies should start small, evaluate and test as they go, make continuous improvements, and build slowly.

Outside money should come into the picture only after entrepreneurs prove their ideas and discover the tactics that work. Following lean thinking principles will prevent the founders from being diluted by outside money that is used to discover a strategy. It will prevent founders from losing control of their company before they can figure out what direction they’re going. It will prevent teams from having a false sense of security and from accelerating in the wrong direction.

Question: What are other dangers of raising money? 

6 Things Your CFO Should Do For You

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.

Conclusion 

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.

4 Tips for Managing Business Cash Flow

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.

4. Prioritize 

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.

Conclusion

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?

4 Reasons Startups Need a CFO

Fred Wilson, a prominent venture capitalist and blogger, said, "the CFO is largely about 'what is going to happen and how do we get there?’"(1). How can a CFO fill this role in a startup? This is an important question not only for CFOs but also for the founder, CEO, and board who hire them.

Some startup teams underestimate the value of having a CFO involved from the beginning. They are focused on building and selling a product and think they can get by with a bookkeeper until they get a lot bigger.

Some founders may recognize the need for CFO insight, but they don’t think they can afford one. As I’ve written before, a CFO doesn’t need to be full time. A startup can engage a part-time CFO for very little cost, and often that part-time CFO can get more involved as the company grows.

Here are a some ways a CFO can help a startup from the beginning know what is going to happen and how to get there:

1. Create reasonable financial projections. Notice the word “reasonable.” Founders are often blinded by optimism. This is usually a good thing because it gives them the courage to move forward with their idea. But often they need a CFO to ground them in reality.

Sometimes startups take off like a rocket with crazy margins and never look back. The reality is that most startups take several years to be profitable, if they get there at all. An experienced CFO will build a financial model with several scenarios. To humor the founder, they can show the rocket ship scenario, but they will also show the normal and worst-case scenarios so the team can plan accordingly.

2. Provide credibility for investors. Investors want to know that their investment will be carefully watched over. They will have to buy into the founder’s vision, but they will also want to know the founder has competent advisors to help carry out the vision.

They will also want to know that they will get reliable financial information on a regular basis. They will be more likely to invest and continue investing if they know an experienced and trustworthy CFO is providing this information.

3. Track and interpret data. Any bookkeeper can categorize transactions and prepare the standard financial reports. An experienced CFO can identify key metrics, create systems for tracking and reporting these metrics, and help other leaders interpret and act on the data.

4. Create scalable processes. Startups are chaotic, and to some extent this is good and necessary. A startup should rapidly experiment and adapt to lessons learned. It would be a waste of time and energy to create too many formal processes. However, as the business starts getting traction, it needs to be prepared for rapid growth. An experienced CFO can help create business processes that are efficient and scalable.

My experience 

I’ve had several experiences where I was brought in after the startup phase, and the founders have kicked themselves for not involving a CFO earlier.

I joined one company about two years after startup. Revenue grew rapidly, but they couldn’t figure out why they were struggling with cash flow. They knew what their manufacturing costs should be, but they had no system for tracking actual costs per unit produced. It took some digging into past data to find that their labor cost was double what they expected.

I put a simple system in place for tracking labor cost per unit. We cut labor cost in half after a couple of months of using that data to refine the manufacturing process. To this day we use the same tracking system, which allows us to quickly make adjustments if labor costs start to creep up again.

The CEO had said many times that they could have avoided many costly mistakes if I would have been involved from the beginning. It’s not that I’m anything special; they simply needed insight from a CFO.

Startup founders: don’t overlook the importance of involving a CFO from the beginning. You will minimize mistakes and increase your chances for success. In most situations a part-time CFO can help you get started with minimal time and cost, and often that person can grow with you until you’re ready for a full-time CFO.

Question: How has a CFO helped you in the startup stage?

(1) http://avc.com/2011/10/vp-finance-vs-cfo/