"Your Business is Only as Good as Your Accounting System" by Dave Baldwin
This article may be a rude awakening for a number of small businesses. You may bake the best cupcakes, deliver the best massages, or engineer the fastest and most secure computer systems, and still be held back by your accounting system. It's a sad thing when businesses make amazing products or invest years of sweat equity to build a stellar reputation -- only to watch it all crumble because they didn't build a robust financial infrastructure to support it. The cold hard truth is that every business's accounting system (or lack thereof) is ultimately what makes or breaks the business.
What does accounting have to do with your competitive advantage?
The competitive advantage of a business is that which your competitor cannot easily duplicate. In Rule #1, investor Phil Town details the approach by which he follows Warren Buffet's methods for investing in companies. One of the criteria is what he calls "moats," or layers of protection around the proverbial castle that comprises a business. One type of moat is a well-established brand name. Even if a competitor builds a superior product at a lower price, they cannot copy or take away brand recognition. A strong brand does not guarantee success in itself, but it is a key factor in the longevity of a business.
Now, let's take a look at how management systems play a role in competitive advantage. Let's use a hypothetical example of two marketing agencies. Both agencies have highly creative talent. Both are well-known in their markets. Both work with high-profile clients. Both have a well-established track record for delivering great service. But they diverge in one area: accounting. We'll call them Agency A and Agency B.
Agency A has a basic nuts-and-bolts accounting system. They keep track of their costs, they know how much money they have. They know their cash flow, and they know their break-even point. They know how many client engagements they need per month to cover their overhead expense and taxes. The goal of Agency A's accounting system is to keep the lights on. And it works.
Agency B, on the other hand, looks at accounting differently. They aren't just trying to survive; their goal is to grow. Their goal is to dominate their space and scale their business to twice its current size over the next two years. They have built a system to support their objectives.
Now, let's take a look at the difference between their accounting systems.
Sales, Marketing and Revenue Forecasting
Agency A knows how much revenue they bring in each month. They have a rough estimate of how much they are likely to make for the next six months, based on their recurring monthly revenue from regular clients as well as a few deals in the works that they expect will close soon. They exhibit at a couple of expos each year, and they've found that these usually generate enough business to pay for themselves. They don't feel the need to examine any data, because they know that certain marketing tactics work if you just do them. They don't take clients whose budgets are too small. They will never say no to a client with a big budget, unless they just can't do the work.
Agency B knows how much revenue they bring in from each of their major service lines, and they've used their accounting system to determine which types of services are the most consistently profitable. They track their marketing campaigns and sales activity relentlessly, and they pay close attention to how much it costs them to acquire each new customer. They notice where their best customers come from, and how many marketing touches each one required. Based on this data, they constantly fine-tune their campaigns and focus their advertising spending on the most effective marketing channels. They are sometimes surprised at what the data reveal. They are not concerned with how big or how small a client is; only whether the job is profitable and whether the client is a good fit. They take pride in their track record of starting with small clients and helping them grow. They have also walked away from multimillion-dollar accounts when the risk was too high.
Talent Utilization and Capacity
Agency A tracks time spent on client projects with a reasonable degree of accuracy. They have a pretty good sense of how busy everyone is. They are very cautious about hiring, because they've made the mistake in the past of hiring too many people and then needing to let some go when business slowed down. They often use independent contractors and freelancers as a stop-gap measure when large projects come in or when work becomes unusually busy. They like having a flexible work force that can be called on an as-needed basis. Hiring full-time staff is generally a rarity unless someone leaves the company, so they usually do not advertise for new talent. When they do hire, they are often in a hurry to fill the position quickly because it is in reaction to a sudden upswing in work, so they can't be as selective as they would like to be.
Agency B is rigorous about utilizing their team's time and talent in the most effective possible way. They have broken down each service line into standard operating procedures, and they have defined benchmarks detailing reasonable time spans for completing tasks. When they notice that tasks are taking longer than usual to accomplish, they investigate to figure out why. Agency B's management carefully watches the team's capacity and is always advertising and interviewing candidates for their next team member. They are always anticipating growth, and they know when to pull the trigger on a new hire based on their sales pipeline and capacity of their current team. They view the next hire as inevitable, and they recognize that finding the right person may take time, so they are always advertising and interviewing whether or not they have an immediate need.
Company Culture
Agency A has a ping pong table and free coffee in their employee lounge. They take pride in having a hard-working team, but also a laid-back office. Employees generally like working there, and the pay and benefits are comparable to the rest of the industry. Communication is good overall, and people have a lot of flexibility to do their jobs in the way that they prefer- as long as the work gets done and the clients are happy. People sometimes work from home, and they enjoy the flexibility to adapt their schedules to the needs of their families, to a reasonable degree. There is no obvious path for advancement at Agency A, but management points out that there's plenty of room to grow for people who take initiative. They've been frustrated a couple of times when their best people left to take jobs in larger firms or to start their own businesses. There have sometimes been grumblings about inconsistencies in pay, but the owners feel that this is not justified.
Agency B has a no-frills workplace. Everyone discussed the idea of adding perks like a nicer employee cafeteria, but since the company has a generous profit-sharing plan, and everyone feels a sense of ownership in the company, no one wanted to spend the money on extraneous benefits. At Agency B, everyone loves their work. They know their numbers, and everyone is fantastic at what they do. There is never a boring day at Agency B, because they are always taking on new challenges. Since the company is always growing, new opportunities for career growth are always emerging. It is rare that the company makes a bad hire, and when they do, it becomes apparent quickly. The wrong people weed themselves out. There is a sense of friendly competition among the team. People work different schedules, but everyone is dedicated and working hard, and no one doubts it. Because everyone's job is measured against benchmarks, there is never any question as to who is performing and who isn't.
Which agency would you rather work for? Which one would you be more likely to invest in? Which one's services would you be more likely to retain?
Every single competitive advantage listed here, and countless others, all boil down to accounting systems. There is one difference between best-in-class businesses and average businesses, and it all boils down to their accounting systems. As boring as it might sound to some, the accounting system of a business is what creates the clarity and insight to make decisions. Businesses that have imprecise accounting systems tend to make decisions based on feelings, and people tend to perceive feelings as more accurate than they really are.
If you're weighing your options for next year and considering what investment of time and energy will make the biggest difference, the first place to look is your accounting system.
Dave Baldwin is an integral part of The Bookkeeper staff experienced in marketing and management consulting. His own entrepreneurial journey was spurred on by a desire to help introverted entrepreneurs succeed in business.
FLSA Compliance: Three Distinctions to Understand in Classifying Workers
The Fair Labor Standards Act has been in the news a great deal, lately. Multiple class-action lawsuits have been filed on behalf of unemployees who believe they have not been fairly compensated.
Many of these lawsuits have ended in either large settlements, or employers paying hefty fines and back wages.
To ensure that your business is in compliance with FLSA guidelines, understand the following three distinctions in classifying those who work for your business.
Who is a contractor and who is an employee?
Some employers have tried to lower their wages and tax liabilities by hiring independent contractors in place of employees. This is an option so long as you follow the criteria for contractors.
Per the IRS's "common law rules", there are three categories assessed when judging whether a worker counts as an independent contractor.
Behavioral Control. For an independent contractor, the business does not direct or control how their work is completed.
Financial Control. If the business controls financial or business aspects of the worker's job (such as purchasing equipment, advertising the worker's services, etc.), the worker is an employee.
Type of Relationship. Whether a worker is an independent contractor or an employee is determined by such aspects as the duration/permanency of the relationship, contracts describing the relationship, benefits provided to the worker, and whether the work performed is "a key aspect of the regular business of the company".
In addition to the IRS classifications, the U.S. Department of Labor provides their own "six-factor realities test" to determine whether a worker might be considered an independent contractor.
1. Is the work an integral part of the employer's business? This is similar to the language in the IRS rules regarding type of relationship.
2. Does the worker's managerial skills affect their opportunity for profit or loss? In other words, is the worker managing the business of the services they provide (for better or for worse) or is the employer directing that?
3. Compare the worker's relative investment to the employer's relative investment. If the business is providing the supplies, equipment, training, etc., the worker is likely an employee.
4. Does the work require specialized skills and initiative? Independent contractors are frequently professionals with specific skills over or in addition to those of the company's regular employees.
5. Is the relationship permanent or indefinite? Though they may work for the company for a very long period, contractors typically operate on a project-based or monthly contract.
6. What is the nature and degree of employer control? This correlates with the "behavioral control" aspect of the IRS common law rules.
Incorrectly classifying employees as contractors shifts tax burden to the workers, a misattribution which might later be remedied in court.
Of course, even if you only hire employees and no independent contractors, you still need to know...
Which employees qualify for exempt status?
"Exempt" employees are, essentially, those to whom you do not have to pay overtime. (Specifically, they are legally classified as being excluded from the FLSA overtime rules.) Non-exempt employees must be paid overtime in any period in which it is earned. As might be surmised from the topic of this article, knowing the distinction is important.
Certain professions are essentially exempt by definition. These are typically the classic "learned professions", such as doctors, lawyers, teachers, clergy, etc. However, they can also include high-level administrative positions. This does not mean that you can sit a secretary at the front desk for 60 hours a week and not pay him or her overtime wages. To be considered high-level, administrative employees must be intensely involved in the running of the business, or in assisting executives to do so. Think of a character like Pepper Potts from "Iron Man", who helps keep Stark Industries running by managing every aspect of Tony Starks's life. She would qualify for exempt status. (If you're not a fan of superhero movies, think of Emily Blunt's character in "The Devil Wears Prada".)
Excluding those jobs which are already considered exempt, there are three "tests" a position must pass to be considered exempt from overtime.
1. The salary level test. An employee must be compensated gross wages of $455 weekly ($23,600 annually) to be exempt.
2. The salary basis test. For any week in which any amount of work is performed, the employee is guaranteed a minimum amount. (Typically, the weekly figure is calculated by dividing a contractually-guaranteed annual salary.)
3. The duties test. This is actually three tests in one, and is designed to protect employees from being labelled "managers" in order to deprive them of overtime wages. For someone to be accurately considered an exempt supervisor:
a.) He or she must supervise two or more other employees.
b.) Management must be their primary duty.
c.) He or she must have genuine input into the job status (hiring, firing, promoting, etc.) of other employees.
To give an example, a store cannot put someone in a "keyholder" position (where they might just be the "Manager on Duty" available to customers, but with no genuine managerial authority over other employees, and the majority of their duties not specific to managers) and then work them over 40 hours a week without overtime.
What if the worker in question is not a contractor nor an employee? What if it's just a young person hanging around to learn the ropes?
For our third and final category, we are discussing...
When should interns be paid?
There have been several high-profile lawsuits recently regarding wage theft of unpaid interns. Young people hoping to get a "foot in the door" in their industry of choice were instead worked ragged with no compensation.
Fortunately, the U.S. Department of Labor has provided a clear six-part set of standards to determine whether an unpaid internship is valid under the Fair Labor Standards Act.
1. The internship must provide similar vocational training to an educational environment. The internship should resemble an educational training program more than it does a job.
2. The intern should be the primary beneficiary in the relationship. In other words, the intern should receive more education and experience from the employer than the employer receives work out of the intern.
3. If the intern is performing work for which the employer would have otherwise hired additional staff or required staff to work additional hours, the internship should be paid. Again, the employer can't use an unpaid internship to get work performed without compensation.
4. There should be no immediate benefit to the employer and the internship should be to the intern's interest. The employer might even be temporarily inconvenienced by the internship. However, under the ideals of an unpaid internship, it is presumed that the employer might recover long-term benefit from later hiring the intern as a well-trained employee, already familiar with company culture and procedures.
5. An unpaid internship can come with no job guarantee. This prevents employers from stringing along an intern for free work with the lure of future employment.
6. Both parties understand that no wages will be paid. An intern must be made aware from the beginning (before their first day at the internship) that this is not a paid position.
Success Stories: The client who got a financial makeover
A good deal of the time, business owners don't recognize potential issues within their company until they become real problems. By the time those issues are discovered, drastic actions are required to remedy them.
That was the case when Craig was approached by a friend who, bluntly and truthfully told him, "I have no idea how my business is doing."
A surface look at his financials didn't present a clear answer. He was billing plenty, but there just wasn't much money left in the account at the end of each month. He couldn't see where the money was going.
So, Craig dug deeper.
He went through all of their financials for the past two years and found a few areas of concern. The biggest problems were:
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All personal expenses were being run through the company.
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Net wages were being recorded as gross salary (causing a greater tax expense).
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The company was significantly overstaffed.
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There were no legal documents.
Complicating the issue was that the client actually had an in-house accountant, and The Bookkeeper was only working on this issue in a consulting role.
A change was clearly necessary but, like many changes, that didn't mean it would be easy.
At the next meeting, Craig brought all of these issues to the client's attention. From there, they devised a multi-step plan to get the company in shape.
First, they took all personal expenses out of the company, so they could get a more accurate picture of its financial status.
Second, Craig went back and corrected the two years' worth of payroll entries in the in-house accountant had entered incorrectly.
Third, the client reduced surplus staff (including the accountant).
In the end, the client ended up hiring us for his bookkeeping and CFO work (for a fraction of what the in-house accountant was being paid). There was a great deal of work up-front in cleaning up his financials, but ever since the "makeover", records have been kept accurate and up-to-date, with no issues or surprises.
Here have been the effects of this change:
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All payroll expenses are now accurate.
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The company is staffed at an appropriate level.
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Monthly expenses have been reduced by $4,000.
Most importantly, the client has peace of mind that he knows exactly how well his business is doing, and no new problems are sneaking up on him.