When business owners initially try to start using financial performance metrics to better manage their businesses, they often struggle to get accurate, timely, and consistent metrics reporting. Usually, this is because of inadequate accounting operations.
In this episode we discuss the 3 pillars of accounting operations and the Finance Stack and typical areas in which each may need to be upgraded: People, Process, and Technology.
We define the roles and responsibilities in the accounting and finance function:
We clarify the differences between accountants, tax preparers, auditors, and CFOs as they relate to small businesses.
We discuss how small businesses can determine and get the finance stack they need at a cost they can afford.
Next we tackle two of the most important processes in the accounting function:
Finally, we review technologies that streamline and reduce error risk:
Sponsored by SmartBooks. To schedule a free consultation, visit smartbooks.com.
Welcome to the Empowering Healthy Business podcast, THE podcast for small business owners. Your host, Cal Wilder, has built and sold businesses of his own and he has helped hundreds of other small businesses. Whether it is improving sales, profitability and cash flow; building a sustainable, scalable and saleable business; reducing your stress level, achieving work life balance, or improving physical and emotional fitness, Cal and his guests are here to help you run a healthier business, and in turn, have a healthier life.
Cal Wilder 00:34
Welcome. This is the fourth episode in a series dedicated to the financial operating system. And so as a reminder, the financial operating system is a proven process that empowers small business owners to take control of their business finances and improve their financial fitness. In the first episode in the series, we we helped us identify our why meaning, you know, why are we in business? What are we trying to accomplish by owning our business. In the second episode, we went into some detail about how to assess our current financial position and performance. And we could then compare our current finances against our objectives as business owners. In the last episode, the third episode in the series, we covered the third step of the financial operating system, which we presented the importance of defining specific financial performance metrics that help operationalize and more precisely manage the business towards the desired financial results. Based on our individual businesses and business models, it's one thing to have an objective of, you know, improving profitability, to make enough money to retire at age 65. And then it was another thing entirely to decide what specific levers in the business we needed to pull in order to produce that profit improvement.
Cal Wilder 01:50
And so as we more rigorously start to measure financial metrics, we usually find that we have trouble measuring some of those important metrics. This is because our accounting is not at a sufficient quality to produce the financial reports we need in order to accurately and consistently measure our metrics. Simply put, in order to manage the business using financial metrics, you usually need to upgrade your accounting operations to get the reports you need.
Cal Wilder 02:21
Today, in this episode, we're going to discuss step number four of The Financial Operating System, which is Upgrade Your Accounting Operations. I view there as being three primary components to accounting operations. There's People, there's Process, and there's Technology.
Cal Wilder 02:39
We're going to start with people because people are the thing, people are the ones who actually get it done and you need to drive the the process and drive the technology. So let's think of a pyramid, you know, why base narrow top representing the primary kinds of work that goes into the accounting function, we can refer to this as the finance stack. At the base of the stack, of the pyramid, there's bookkeeping. It's the most tactical part of the accounting and finance function, involving you know, a lot of data entry and a very basic accounting. Then above that we have more hardcore, real accounting, debits and credits, and accounting management. Above that we have financial planning and analysis. And at the very top, we have C level executive management, the CFO role Chief Financial Officer role, which is the most strategic part of the finance function. So let's talk about these roles and functions and titles a bit.
Cal Wilder 03:38
Before we dig into specific roles and titles, I'll just make a an observation that in small businesses, titles are cheap, and they can often end up getting thrown around or assigned or lobbied for, or otherwise used somewhat loosely, you might have a glorified bookkeeper with a controller title, we might have a good accountant or even a mediocre controller who has a CFO title. So let's get clear on what these roles really do, regardless of what titles you might already have in your business.
Cal Wilder 04:13
Let's start with the bookkeeper role. So the bookkeeper post transactions such as customer invoices, customer payments, vendor bills, and vendor payments. At the end of the month, they reconcile bank and credit card accounts. It's role that's heavy on data entering, there's not going to be a lot of understanding of debits and credits accounting and how to recognize revenue and expense using accrual accounting principles. They've been they know something about the concept, but they're not going to be able to implement and manage this system for accrual basis accounting for you. They can, they can click the buttons in QuickBooks to generate financial reports, but they usually aren't going to be able to analyze them for accuracy and reasonableness. And they're certainly not going to be putting together any metrics packages. For you, it's an important function. But there are limitations to that function. There is one exception I'll mention, which is the term "full-charge bookkeeper." I'm not sure how much that term is used these days, but traditionally, a full-charge bookkeeper was a step up from your basic bookkeeper, and it was more like a full service accountant for small businesses with more of an expectation of some accrual accounting and making sure financial reports are accurate and reasonable. Maybe they still needed some outside assistance to help point them in the right direction and answer certain questions, but they were much more self sufficient, then what most of us probably consider a bookkeeper now. So when business owners are growing their small business, usually the first hire they make is a bookkeeper in order functionally delegate work that the owner themselves would otherwise have to do. So the owner is trying to free up time, they're doing too much basic bookkeeping, and it's not adding value value to their business. So they hire a bookkeeper to get that done, so the owner can focus on other things.
Cal Wilder 06:04
And then if we go up a level in the finance stack, we get to the accountant role. I want to clarify some terminology around the term accounting because it can mean different things to different people. I want to make sure we understand what it means for our purposes in running our day to day accounting operations. In public accounting firms where CPAs work, Certified Public Accountants, the smaller firms have accountants doing both tax and audit work. And then larger CPA firms working with larger businesses, public companies, potentially, they tend to split so that the accountant specialize and focus in either tax or audit, because they appreciate the preparing tax returns is very different than auditing financial statements for proper use of accounting principles. So you wouldn't want your, if you're Microsoft, you don't want your auditor preparing your tax returns, you don't want your tax advisor auditing your books, they're two separate functions. Then we take it to the small business space where we all work. Small business owners often refer to their tax preparer as their "accountant". However, for our purposes, we're going to use the term accountant to refer to the person doing the day to day accounting work in your business. And we'll refer to the tax preparer as the tax preparer or the tax advisor. And most of you don't have auditors, so we're not going to worry too much about auditor but you know, there is an audit function if you have a need for an audit due to external sources of debt or equity capital that require an audit or you're preparing to sell the business and you need an audit.
Cal Wilder 07:39
So, in our purposes, the accountant is a day to day role within the business. And so the accountant is going to be familiar with accrual basis accounting for revenue and expense recognition, meaning they know they know the principles of when we can recognize revenue based on when goods and services aren't delivered. When we said we're recognizing expenses, when we accrued the benefit of those expense, they can do debits and credit journal entries. Many of them have a degree college degree in accounting. They're capable of earning most or all of the monthly close themselves. And the more senior the accountant, the more proficient they're going to be with generally accepted accounting principles or GAAP, which those are a fiscal, you know, policies put out by governing accounting bodies that apply to public companies, and anybody who needs to be able to pass a strict GAAP audit. And so the more senior the accountant is, the more GAAP, they're going to understand. And the better they're going to be at figuring out and knowing how to apply GAAP in order to produce audit ready financial statements based on the specific financial operating activities of the business, some accountants will ever in the CPA designation as a certified public accountant. So, you know, accountants are very capable people, however they will have some limited ability to set up financial performance metrics, but they're usually going to need the support of more senior finance experts in order to set up and determine the right set of metrics and establish some goals and in figuring out exactly how to calculate them. But once that system is set up, maybe with some outside help, or some more senior support, the accountants would be able to maintain a set of metrics, reports and provide them to management on a periodic weekly, monthly, quarterly kind of basis.
Cal Wilder 09:25
And then if we go up a step in the finance stack, we get to the controller role was really the overall accounting manager role. It's the most senior accountant responsible for the accounting operations of the business. And so that means defining accounting policies and procedures, you know, what's the, what's technically correct accounting policy that we should apply in this situation? You know, what's a pragmatic way to get that done? You know, if it's too onerous to follow 100% GAAP, how do we get 80 or 90% of the way there by doing 20% of the work? And what are the standard operating procedures, the SOPs, that we need to implement in order to be able to consistently perform that. They think about things like internal controls and segregation of duties to help manage risk. They produce financial reporting packages, which will include your standard financial statements, your income statement, your balance sheet, your cash flow statement was well some other more custom reports based on the business's needs. Controllers are able to do basic budgeting and forecasting, some basic financial planning and analysis. Controllers still tend to be somewhat backward-looking into reporting on the past by nature. For more advanced planning and analysis work and really heavy forward-looking forecasting, typically we need to bring in a chief financial officer to help with that.
Cal Wilder 10:51
One other thing to note about the controller role, it's a little bit different than bookkeepers and accountant. For bookkeepers and accountants, you kind of judge their work product to the extent of their skills and experience and, you know, understanding that some level of more senior support, maybe an outside CPA or a fractional CFO, or somebody may have to mentor and assist them with parts of their work, in order to get their job done, or they may need a controller to help them get done part of their job. But when it comes to the controller role itself, it tends to be judged more by the absolute quality of the accounting function of the business kind of the buck stops with the controller typically-- to some extent, if there's a CFO, the CFO is responsible, too. But if there's no CFO in place, then the buck stops with the controller. So we need to think about, you know, if your business is at a point where there is a controller, you think you need a controller? How do we assess the performance of the controller to make sure you're getting what you need from that function. And so in the book, I'm not going to read from it too much. But there is a checklist in here. And so there's just a few questions we can ask ourselves when thinking about the controller role.
Cal Wilder 12:02
Do the financial statements accurately reflect the performance of the business? Do you feel like they do? Or do you feel like something's different going on the business than you're seeing in the financial reporting? And if so, you're gonna fit you're goning to have to figure out why.
Cal Wilder 12:15
Do the financial statements reflect an appropriate level of generally accepted accounting principles based on the objectives of your business? If you anticipate needing an audit at some point in the near future, in the next 2, 3, 4 years, how close is your accounting now to being able to pass that audit? It may not really matter to you too much. But a minimum level of accrual accounting is required at some point, even if 100%, GAAP is not required.
Cal Wilder 12:48
Question number three, is there a reporting package that provides more complete insight into company performance beyond just the financial statements? So this might include an actual versus budget analysis. Potentially a forward-looking forecast. Is there something else that you're getting on a monthly basis that helps you understand your performance and plan and potentially manage your performances in the reports? Or are you only getting the kind of the backwards looking basic, not that helpful income statement, balance sheet and cash flow statement, you now have to figure out what to do with in order to run the business.
Cal Wilder 13:22
Question number four, do systems and processes run efficiently, consistently and accurately? We want to be efficient, utilize technology, utilize efficient processes, not just throw person hours at work, and then an increasing number of person hours as businesses grow and be efficient and get some economies of scale there. Do we feel like things are running smoothly, because ultimately, the controller is responsible for, really, the accounting operations, not just the accuracy of the ultimate financial statements.
Cal Wilder 13:51
And then the final question here is, are there internal controls to prevent fraud and mistakes? This is a critical one, once the business gets to a certain size, we need to make sure there's segregation of duties. And the same person is not posting bills and approving bills and paying bills. And somebody's looking, doing a review of some underlying transactions compared to what's being reported in the general ledger to make sure that things are getting done accurately. And we have no fraud or embezzlement or major mistakes going on. So those are the kinds of questions we need to be able to ask and answer regarding the effectiveness of the controller function.
Cal Wilder 14:31
And then finally, at the top of the finance stack, at the top of pyramid, is the Chief Financial Officer, the CFO. And so this is a C level executive focused on strategy, analysis, planning and driving overall business value. They are a true partner to the CEO. The CEO in small businesses is usually the founder and owner of the small business. So the CFO is very forward-looking by nature. They are the one in the organization who's defining metrics and goals that are aligned with the financial and business objectives of the business owner. They're doing more advanced Financial Planning and Analysis. Maybe they're designing sales compensation systems, or sales compensation plans. They're maintaining a more detailed 12 month or 24 month forecast. They're getting in, they're really trying to understand the cash flow cycle of the business and how that can be improved. They may be engaging directly with banking relationships, in any kind of merger and acquisition process, and with key policy decisions that the business needs to make.
Cal Wilder 14:31
Good CFOs put themselves in the shoes of the business owner, and think about what the business can do to maximize the equity value of the business for the owners without taking an unacceptable level of risk to try to do that. So of all their roles in the finance stack, the CFO is the most different primarily due the mindset that they bring, they think in terms of finance and return on investment, not, you know, not necessarily, accounting and GAAP all the time. They may have risen through the ranks of the finance stack. They probably know a lot about accounting and GAAP, but they don't necessarily need to be GAAP experts. In larger businesses, that's what controllers are for, to really manage day to day accounting operations and make sure GAAP is getting followed. And in larger businesses, there may be a split between the finance and accounting departments, recognizing there's you know, different skill sets there. That's how it was, at Staples, when I worked at Staples for about a year and a half after they acquired the first business I founded. But in small businesses, you know, there's not a lot of heavy duty accounting to manage, and the CFO often pulls double duty as a controller when needed. And so if we think specifically about what we're trying to accomplish with the financial operating system, and being able to define and measure and manage toward metrics that are aligned with the financial objectives of ownership, you know, that's usually what the CFO does. They determine and implement those systems, they monitor those systems, they revise them over time, and they make sure those metrics are incorporated into the business planning process. And they try to balance your risk reward decisions and help CEOs and owners navigate and make those kinds of policy decisions.
Cal Wilder 17:20
A good CFO is incredibly valuable. But it's also expensive. And so in the small business space, that role is usually fulfilled in a very fractional manner. Meaning not full-time, usually a very part-time manner. But it can be amazing what a good CFO can accomplish in as little as four to eight hours per month. The hourly rates can look expensive, but compared to what attorneys charge, and what tax preparer CPAs charge, it's the same and in often cases, the CFO's hourly rate may be less, and those other roles are focused on compliance, not driving the value of the business.
Cal Wilder 18:02
Not every small business wants or needs a CFO depending on where they are in the stage of their development or lifecycle. But if you are a business owner struggling to get control of your finances and improve your financial performance, then chances are you need some form of CFO resource in your finance stack.
Cal Wilder 18:23
I do want to clarify some of the comments I make about CPAs or what I'm about to say about CPAs. In no way am I being critical of CPAs. I have some CPA friends and my business smart books tries to be friends with all the CPAs used by our clients. However, we need to understand what most small business CPAs spend their time doing, and that's where their expertise lies. Most small business CPAs are tax preparers by trade. Some also do audits for clients who need audits. And it's very difficult to be an expert at tax and audit and manage staff who are primarily tax preparers and auditors, and also be able to be a finance expert advising clients on how to drive their financial performance and maximize the equity value of the business. Right? It's a very different skill set. It's kind of like bookkeeping and payroll I use as an analogy. They seem like they're closely related and the same person should be able to do the bookkeeping and payroll well. But payroll is a very different set of rules and compliance requirements and processes and technology systems and risks. And you don't really want your bookkeeper doing payroll if you can at all avoid it, because ultimately, they can push the buttons in the payroll software and generally you get people paid, but they don't really know what they're doing and the consequences of what they're doing and what the labor laws are and how to make sure you are compliant and stay out of trouble. And make sure that the right tax returns get filed with the right agencies and everything. So similarly, although there are certainly are rare individuals who are great at both taxes and CFO work and can do both at an incredible level, most small business financial professionals working with small businesses focus on one or the other. You don't want your CFO doing your taxes most of the time. And you don't usually want your CPA Tax Preparer doing your CFO work. So my advice is, whenever possible, try to keep the CFO role separate from the CPA Tax Advisor role, so that you can get the best results from both roles.
Cal Wilder 20:38
So now that we've talked about the primary roles in the finance stack in your accounting department, we've got to address the challenge facing small businesses of how do you get the finance stack that you want to need, at a price that you can afford. And so the first step is kind of determining how much of the finance deck you need and want, and then kind of evaluating the staff that you have in place to successfully deliver your finance deck. And so first, let's think back to steps one and two of the financial operating system where we, you know, defined our Why, which is what are we trying to accomplish by owning our business? What are our financial objectives? And then step number two is know how well our current financial performance is meeting those objectives that you set. And so if we try to then use that information to help evaluate how well your current finance stack is serving you, again, I'll refer you to this section in the book, where we have a series of questions we can ask ourselves and consider. If you are receiving regular, accurate monthly financial reports, and you are confident those reports are showing you that the business is pacing on track to achieve your objectives as a business owner, then you may not need to make a change to your finance stack. While you still might benefit from beefing up your stack to improve performance, you would be making that investment from a position of strength rather than weakness.
Cal Wilder 22:10
If unfortunately, like too many small business owners, you are not receiving regular, accurate, insightful financial reporting, and the reporting that you do get shows performance is not aligned with your business objectives, then you need to make a change to your finance stack. And there are two kinds of changes. The first is, you can keep the current components of your stack, replace the people in those functions with people who can better perform those functions. For example, if you employ a controller and you're struggling to try to close the books on a monthly basis or failing to do so, then you may need a new controller. The second kind of change to the finance tech stack would be adding some higher level components to your stack. Your bookkeeper or accountant might be doing a generally good job with the basic accounting, basic reporting, but you may be looking for budgeting and forecasting financial performance metrics. And so in those cases, you might need a controller or CFO within your stack to get the results that you want. So we can ask ourselves the same questions we asked ourselves about the controller earlier, but ultimately, it comes down to you're getting the financial reporting that you need to understand how the business is performing. And are you confident that reporting is accurate? And if you can't answer those questions yourself, then it may be worth bringing in kind of an interim or, you know, very small project based CFO to help you assess your finance stack against those objectives.
Cal Wilder 23:40
And so it can seem like this full finance stack seems like it could be kind of big, it could be kind of expensive, and we'll talk about how it can be affordable to small businesses. But I would encourage you to consider the benefits of this as well. Some of these might resonate with you more than others. But with a great well functioning finance stack, we'd be on top of customer billing and collections to accelerate cash flow and and minimize bad debt. It would be largely self managed, so you can spend your time growing your business and not micromanaging your bookkeeper or your accountant. It would provide you with timely and accurate financial reporting and performance metrics so you have actionable information you can use to manage the business toward your objectives. Your books will be kept in order for prompt annual tax returns and your ability to do tax planning over the course of the year. We reduce the cost of your CPA if your CPA is billing you, your tax preparer CPAs, is billing you at the end of the year to clean up of messy books come tax time. And then finally you'll have upgraded internal controls in order to avoid embezzlement and fraud.
Cal Wilder 24:51
And so, I think we can understand the components of the finance stack, the roles that are in there. We can understand there's definitely some benefits of having a great finance stack in place. But let's think about how we can afford that in the small business space, where you really don't need a full time bookkeeper or full time accountant, full time control or full time CFO. And even if you would like all those things, you definitely can't afford all those things as a small business owner. And so we have to think about this in a fractional way. Or we could go down the route of thinking, what if we just hire one individual and have them do as much of this finance stack as possible so we could hire a full time employee of junior level can have a bookkeeper a junior accountant level that may be affordable, you might be able to afford a full time, you know, bookkeeper/junior accountant, but you're not going to get the higher level functions in your finance stack that you may need-- you may not get real, accurate accrual basis financial reporting and performance metrics you need to manage the business. But you probably can't justify the cost of a full time employee to be a really solid staff accountant, or controller, and you can almost never afford a full time CFO. And even if you hired or could afford to hire full time CFO and hired one, they wouldn't want to do the lower level bookkeeping accounting and at this point in their career as a CFO, they might not even be that good and efficient at the lower level work. So the small business owner is in a bit of a bind, when it comes to staffing their finance staff. And so that's why the trend of hiring an outsourced firm that can supply the right fraction of what you need is increasingly popular. A firm is geared towards supplying 1/4 of a bookkeeper plus 1/8 of a controller plus 1/16 of a CFO, if that's what you need in your finance stack. It wasn't really until about 15 years ago that this became viable when small business accounting software systems moved to the cloud and became available in a SaaS model. And so this is when this whole industry of outsourced cloud accounting came about began. This whole industry is still somewhat young. There's a big difference between firms that have figured out how to deliver the fractional finance stack, versus those that operate in what I call a staffing type model where they mostly supply one part time person and, you know, not really deliver the full finance stack, just whatever that one part time person can do.
Cal Wilder 27:26
We spent a lot of time on the people part of accounting operations. And I think that's proper, because they're the ones who drive everything. Without the right people, you're not going to be able to develop and implement manage the processes and technology you need for optimal financial performance. But let's move on and discuss the other two parts of the accounting operation. So let's talk about a couple of select topics related to processes and then technology as you consider what might need to be upgraded in your accounting operations.
Cal Wilder 28:08
The first process I want to cover is the monthly close process. While there are different kinds of processes that need to be managed in the finance department, the monthly close is the one I want to really focus on first. It's usually where the low hanging fruit lies. Beefing up the monthly close will have dramatic results most of the time, and it will identify other processes that need to be addressed and implemented or upgraded.
Cal Wilder 28:35
So what is the monthly close? Is that set of methodical tasks that get repeated every month to ensure that the financial reports are produced and are accurate. So these are tasks like reconciling bank accounts, reviewing delinquent customer invoices for collectability, analyzing revenue and expense accounts for accuracy when they vary from prior trends. Maybe posting revenue and expense recognition recognition entries if you're following accrual accounting principles. The set of tasks that go into getting the financial reports are ready at the end of the month.
Cal Wilder 29:16
So there are two parts that go into having a good monthly close. The first is creating and following a monthly process to be able to complete a true monthly close, which is more than just reconciling bank and credit card accounts. It's making sure that ultimately there's a you know, the account the financials are accurate, not just you know that we've reconciled the bank and credit card accounts.
Cal Wilder 29:38
And then the second part of the monthly close is engineering the process of the monthly close so that it can be completed as fast as possible, given available staff capacity and other competing priorities of the business. So the business typically benefits from completing the close as fast as possible so that managers can get the financial information as soon as possible to be able to act on it. And so if employees stopped what they were doing and worked full time on closing the books, they could probably get done in a few days with proper accounting management in place. However, that's not really realistic. You know, generally in small businesses, we can get the books close by the 15th to the 20th. That's a pretty good outcome for businesses that typically have a part time bookkeeper or accountant or outsource it to a firm and when they have managers that have other priorities to perform in addition to their parts of the month they close.
Cal Wilder 30:36
The goal here is engineering the process is to minimize the bottleneck of as many tasks as possible that need to be completed in a short period of time after the end of the month. Some of these tasks can be completed during the prior month. For example, payroll can be posted the day after every pay day. Customer and vendor payments can be posted as they are made. Bank and credit card registers in QuickBooks can be updated every week with new activity and any unknown transactions can be analyzed and resolved every week. Revenue and expense details can be reviewed for accuracy over the course of the month, right? And so the objective is to accomplish as much of the closing process before the end of the month as possible so that we can minimize the number of closing tasks that cannot be completed until after the end of the month. Making sure that there's a good process in place, or the proper things are getting looked at and analyzed and engineering the process so that it can be completed as fast as possible is really key to having a great monthly close.
Cal Wilder 31:44
The second process I want to address is implementing an accrual basis accounting process. Often as part of upgrading the finance stack and the monthly close process and getting the ability to calculate accurate financial metrics, we see there's a need to implement more formal accrual accounting. And so accrual accounting refers to the practice of recognizing revenue and expense in the time period in which goods and services are provided, received or consumed. It's different than when invoices are dated when bills are dated. Or when those bills and invoices are paid, right? That would be more cash basis accounting if we're recognizing revenue and expense based on when our customers pay us, and when we pay our vendors. In accrual accounting we recognize revenue when we deliver the goods and services to our customers. We recognize the expense when we consume receive the benefit of goods and services provided to us by vendors.
Cal Wilder 32:50
I mentioned generally accepted accounting principles earlier, GAAP in shorthand. So small businesses rarely need full GAAP. There may be a small number of high growth venture backed companies that are expecting or rapid acquisition or IPO and maybe need GAAP accounting. But for the the vast majority of us, we want to get reasonably close on you know with basic accrual of revenue and expense recognition. Sometimes this is a matter of adopting a few basic practices. In other times it may be more complicated and you will need a skilled accountant to manage revenue and expense recognition schedules for you. There's a chapter in the financial operating system book that goes into further detail on cash versus accrual accounting, and why accrual accounting is ultimately where growing businesses that want to manage their business by the numbers and up. But what I was just say here is that accrual basis financial reports provide much better insight into how the business performed in a period of time, you'll start to really get more insight not only from the income statement, the profit and loss, the P&L, but also from the balance sheet and the cash flow statement.
Cal Wilder 34:04
Small businesses can really get 80% of the benefit of GAAP with about 20% of the work using what I call the management and accrual accounting standard. Now, it's not a technical official standard you're going to find referenced in accounting literature. But it's something that we've really defined over the years that delivers that 80/20 solution where you get 80% of the benefits of GAAP with about 20% of the effort and associated cost until there are a few primary tenants or practices that that go into management accrual accounting, they get you that 80/20 solution.
Cal Wilder 34:36
So the first one is date customer invoices in the month goods and services are delivered to your customers. So, if you're in the habit of invoicing customers in the first few days of the following month, if that's your process or practice, you don't need to date those invoices on the third or fourth of the month. They can be dated on the 31st of the previous month. Then you don't have to worry about accruing or deferring revenue-- you've posted the invoice in the date in which goods and services were delivered. Similarly, inversely, we can date vendor bills in the month goods and services were delivered to you. So if you've got a service provider, you know, if your attorney bills you for the for the month on the fifth or sixth of the following month, and their invoices dated on the fifth and the sixth, there's no reason you can't put that in with the date of the 31st of the month in QuickBooks. That saves you the trouble of having to worry about whether you should accrue the cost of those legal fees into the previous month and have to maintain a balance sheet schedule and worry about human error and understanding how to do that and everything. Just date the bill in the month the services were received. It doesn't really matter, pay it on time, and your books will be more accurate.
Cal Wilder 35:55
Then we want to capitalize and amortize or depreciate any particularly large asset purchases, with a treshold that is reasonably high. If you buy a computer here and there, you don't have to worry about it. But you know, if you buy an automobile, or you spend $50,000 on an office renovation for the office space that you work in, for those kinds of expenses, we should set up and amortize or depreciate over time. So maybe $5,000 or so is a reasonable threshold to worry about. Things over $5,000 we want to look at and see if it's something that we're going to accrue some benefits from over time. If it's an annual insurance policy that cost $20,000, that's something that we should amortize over 12 months instead of booking all upfront. If you're worried about the tax consequences of this, your tax CPA can still file your tax return on on a cash basis to get the full benefit of that expense in year one, potentially. But from the perspective of being able to utilize accurate monthly financial statements and apples to apples comparisons without huge skewing effects of those months in which you make these large purchases, you're going to want to amortize and depreciate them over a certain period of time.
Cal Wilder 37:16
And then the fourth tenet is, if possible, pay employees on a semi monthly basis, not bi-weekly. Semi-monthly means twice per month. Bi-weekly means every two weeks. They can be kind of used interchangeably, because you know, one month has approximately four weeks. However, it has 30-31 days most of the time. And so that is more than four weeks. The effect of those few extra days most months means some months, typically two months out of the year, there will be a three payday month. And you will recognize the cost of three paydays in your books instead of two, those couple of months out of the year, and your numbers and new metrics will be really skewed. If you're really trying to be able to accurately report on payroll cost, you're going to need to implement an accrual basis payroll cost accounting method in order to recognize one month of payroll instead of four weeks of payroll every month. The caveat is in some states, in most states, if they're hourly employees then they do need to be paid on a weekly or bi weekly schedule in which case you will need to implement some accrual accounting around payroll. But whenever possible for full time salaried employees pay on a semi-monthly basis instead of a bi-weekly basis, and then you can avoid having to worry about any sort of accounting accrual and you know that every month you will have one month's worth of payroll costs in your books. So this management accrual standard is not concerned with the finer points of GAAP and Financial Accounting Standard Board proclamations, but it will deliver reasonably accurate financial statements reflecting the performance of your business, which can be timely produced at a reasonable level of effort and cost.
Cal Wilder 39:14
I want to move on to the third major area of the accounting operations, which is technology. We've talked about our people, we talked about a couple of major processes, and then we want to talk about technology. Luckily accounting technology for small businesses has come a long way in the last 10 to 15 years with the rise of all the software as a service products that are really geared toward the small and mid sized business market.
Cal Wilder 39:40
The first and primary central piece of technology is the general ledger system, the GL system. QuickBooks has about 90% market share in the United States. It's very widely supported just about any bookkeeper or accountant who's ever worked in a small business knows how to use QuickBooks. It has a relatively broad feature set. And it's not going anywhere. It's part of a big public company into it. And it was TurboTax and other things. So it's very stable. And I would say, unless your industry or business model needs a niche solution that's very specialized to meet the specific needs of your specific industry, your business model, than QuickBooks is just the logical solution to use as the GL system. The GL system you use is not going to be a competitive advantage most of the time. I've never seen the GL system be a competitive advantage in the small business space. So I would say use the standard solution.
Cal Wilder 40:46
As part of implementing and managing and using the GL system, there will be a chart of accounts that needs to get set up and manage. And this is where there's overlap here, between the technology and the processes, because as part of upgrading the monthly close and maybe implementing some accrual accounting, and ultimately using financial reports to calculate financial metrics you need to manage your business, you'll usually find that you need to make an upgrade to your chart of accounts. So what is the chart of accounts? It is that list of all the accounts that transactions get booked to or coded to. And it's the list of accounts that appear on the financial statements when the financial statements are generated. And so these accounts are divided across, you know, different kinds of revenue, different kinds of expenses, different kind of assets, different kinds of liability and owner's equity. And these accounts in the chart of accounts are often called general ledger accounts, or GL accounts, and they're configured in QuickBooks or whatever General Ledger software that you are using. And these, you know, general ledger systems typically come with a pre configured Chart of Accounts initially, and over the years, they tend to evolve out of out of control into a mix of, you know, what I call Frankenstein, and spaghetti. After several years, it can just really be out of control. And the reason that really matters aside from it might be inefficient to have, you know, a large disorganized group of accounts to try to code things against us. It really matters because the structure of the chart of accounts directly impacts the structure of the financial reports that you can produce. And so by structure, just to clarify, meaning, you know, the names and the account numbers, how those accounts are grouped together, the order of those accounts, and the use of any dimensions extra kind of secondary codings, like class or location that can be used to track different business segments, such as departments, or business lines or geographic locations, things like that. And so we need to make sure the chart of accounts is aligned with the company's financial reporting needs, or it will be almost impossible to produce the required financial reports in any reasonable period of time with any reasonable cost without too much potential for human error.
Cal Wilder 43:19
The first thing to consider when thinking about the chart of accounts is what's the structure of the financial statements and other reports that managers need in order to run the business? And what line items do we need in order to calculate the financial metrics that we think are most important to be able to manage in our business once we've determined those two things, then we can you know, go back and revise the chart of accounts. Go back and refer to to episode number nine of the podcast which covered step two in the financial system, assessing your current finances were in that episode, we reviewed the income statement and balance sheet structured and, and how they how those accounts can be segmented or grouped in order to calculate commonly used metrics. So I'm not going to go into a lot of detail again about upgrading the Chart of Accounts, just simply say that the standard segments and groups in which the GL accounts and be you know, ordered would include you know, revenue, cost of goods sold, cost of service delivery, marketing and sales, general administrative, and other income and expense. And so all the GL account should be grouped into one of those segments.
Cal Wilder 44:30
In addition to getting the groupings and the name squared away, a logical account numbering scheme makes it a lot easier to post transactions and navigate reports and quality control the books. You may have account names that can be similar, and the name alone might not convey what the account is really used for. You might not really just be have a look at it and see if transactions are accurately booked there. However, if we have a logical account numbering scheme, it will really help. For example, if all costs of goods sold expense accounts start with number five, and marketing and sales accounts start with number six, and general administrative expense accounts start with number seven, it's now much easier to kind of use and navigate those accounts and quality control the work.
Cal Wilder 45:18
We've talked about general ledger, we've talked about the chart of accounts that are managed within the general ledger software. Let's talk about couple ancillary systems that become very important as your business grows. So the first area is Accounts Payable automation. Now, you've probably start out with QuickBooks, and you post bills and pay bills out of QuickBooks. And historically, you know, you'd have a weekly check run of paper checks that the bookkeeper would bring to the owner for signature once a week and stuff envelopes and mail out. And there's still a lot of paper checks being used. In the US. However, there are technology based Accounts Payable systems that can be a lot more efficient. And frankly, they may be required now in a much more remote work environment where the accounting function doesn't sit next door to the, you know, the CEOs office and you can't just walk next door with paper checks to sign that may not be feasible anymore. And we've seen a lot more small businesses implement these automated AP systems in the last few years since the COVID, lock downs and 2020 forced them to.
Cal Wilder 46:31
AP automation systems are sometimes called you know, the the 'procure to pay" system, the "procure to pay" process. It could start with a purchase order, you know, where you place an order to procure something from a vendor. Usually, in small businesses, it starts with a bill though as there's maybe no formal purchase order, but there's a bill that comes in. So if here's some steps in this process. We have to receive that bill. We can receive that Bill via electronic format and have it automatically go into our AP system, not somebody's inbox, that's a lot more efficient. And needs to get looked at and posted by the bookkeeping or accounting function. It's then approved by a manager or the owner. This approval step is critical to have some segregation of duties as part of internal controls for the business. Bookkeepers unfortunately steal a lot of money from small businesses because of a lack of internal controls. So it's critical that bills get approved by someone other than the poster. There could be a two step approval process above a certain amount. There should be an audit trail within the system that shows who approved what, when, and if changes were made after the approval. Once the bill is approved, it can be paid. Payment electronically by ACH is faster and less expensive than paper checks. So these AP automation systems should be able to issue ACH payments. Then the payment disbursement out of your bank account needs to be posted to the general ledger, so you can have accurate financial statements in the general ledger. QuickBooks does not provide this level of automation, unfortunately. And once you reach a certain volume level where efficiency becomes more and more important, then you'll need another system that manages this AP process and synchronizes the data with your general ledger software. As of today, Bill.com is the gold standard for small business accounts payable automation. However, there are other systems out there too, that you know that function similarly. But the first one, if you haven't had exposure to an AP automation system before, the first one to check out as bill.com to learn the lay of the land. And then if you want to shop around for another one that you think may be a little bit less expensive, or might meet some specific need of yours, then you really still have the reference point from bill.com about what these things look like and can do.
Cal Wilder 48:55
Now, on the flip side of AP automation, we would have accounts receivable automation or AR automation. There are more variables to consider with accounts receivable depending on what you sell, how you sell, where do you sell it, do you sell it on websites, retail stores, do you send invoices to other businesses, is it a subscription based business model, etc. As with AP, there's a process. With AR, it's sometimes referred to as the "quote to cash" process, because it might start with a quote, and it ends up with cash in your bank account. And there's some steps in between. There might be a quote, there might not be a quote, but there's some kind of a sales order that gets placed. There's an invoice that gets generated. There's a payment that gets received. That payment gets deposited into your bank account. This can be automated. Once you get a certain level of sales volume, you're going to need that efficiency. Or maybe right out of the gate if you have certain business models. If you have online shopping cart sales, you may want to automate this right out of the gate. There are a lot of different software options, so I'm not going to recommend any one in particular.
Cal Wilder 50:09
One of the features to look for with whatever AR automation system you think is the right fit for your business operations, is the ability to ability to integrate the data into QuickBooks or whatever your general ledger software is. We want to avoid the need for data entry to re-key data that already exists in the accounts receivable system. We need to decide what data we want to see in the general ledger. We might not need every particular step in in the AR process in the general ledger. If we're doing thousands of transactions per month online, and putting all that data into QuickBooks could be cumbersome. We have to figure out what data needs to go in there and then get that integration setup. Now, if the integration is not feasible, a skilled accountant can still work with reports from your AR system to create and post manual journal entries to the general ledger. Now that is cumbersome, the reports are not always clear, it can be hard to interpret them, it takes time that slows the monthly reporting, and it's subject to human error. There's no one size fits all with accounts receivable automation to the extent bill.com is typically kind of a plug and play system on the accounts payable side for most small businesses.
Cal Wilder 51:31
Then the final part of the tech stack with an upgrade opportunity would be online employee expense reports. You know, these are systems such as Expensify. Expensify has kind of become the Kleenex name for employee Expense Report automation systems, kind of like the standard default name people refer to them by but there are a few really good systems out there. Another one I like is Tallie. There are some differences between these systems, but they generally all work the same way. The system links to the employee credit card. It downloads transactions from the credit card company automatically and presents them to the employee to code. They integrate with QuickBooks or your general ledger system to pull in your chart of accounts and maybe class and location dimensions if you're using those. You might be able to create a dumbed-down list of expense types in in the system that you would map to GL GL accounts to make it easier for the employees to pick their expense type. The employee codes each transaction to an expense type or a GL account. They upload images of their receipts. They all have mobile apps so they can snap a phone photo of the receipt with their phone and upload it and attach it to the transaction. If you have mileage reimbursement, they can plug in their trips and mileage calculations will be done automatically. Once the expense report is completed by the employee, they submit it. A manager approves it. It gets posted to the general ledger. And then if it's reimbursable to the employee, it may also then post to an accounts payable system outside of QuickBooks that that's used to pay bills.
Cal Wilder 53:08
Employee Expense Report automation has three major benefits. The first benefit is fraud mitigation, as they force expenses to be reviewed and approved by managers. The second benefit is tax and audit compliance as the source documents, meaning the receipts are uploaded and retained by the system. The last I checked, IRS standards required expenses greater than $75 to be documented with a receipt and a statement of business purpose. We can have policies that require the employee for example, if they're expensing a meal, to list the people who attended the meal and the business purpose of the meal. When managers are doing their review, they can make sure the business purpose is defined in the transaction. And then the third benefit is more efficient and accurate accounting. Bookkeepers won't know how to code certain transactions just by looking at a credit card statement or an electronic feed into QuickBooks, especially if the business uses Job Costing or class tracking or other dimensional reporting beyond just the expense account in the chart of accounts. The employees who have the credit cards know what the purchase is for and they can easily supply that data as part of the coding process. Then it automatically synchronizes accurately into the general ledger system.
Cal Wilder 54:35
To wrap this up, I hope you've gotten value out of this episode to be able to think about what parts of your accounting operations need to be upgraded in order for you to get the financial reporting and performance metrics that you need to manage your business. If you would like someone to help with assessing and upgrading your current finance stack of people process and technology, you can schedule a consultation with me. I can help lead you through the process for your business and help you get a better result from your accounting and finance function.
Cal Wilder 55:08
Reference show notes and find other episodes on EmpoweringHealthyBusiness.com. If you would like to have a one-on-one discussion with me, or possibly engage SmartBooks to help with your business, you can reach me at Cal@EmpoweringHealthyBusiness.com or message me on LinkedIn where I am easy to find. Until next time, this is Empowering Healthy Business, the podcast for small business owners, signing off.