This article by Rick Segal was originally published in Corp! Magazine, November 19, 2015 issue.
Leon Danco (of blessed memory) is considered the grandfather of family business consulting. He leaves behind his “twelve commandments” for family business owners and number five is:
“Thou shalt institute an orthodox accounting system and make available the data therefrom to thy managers, advisers and directors.”
Beauty is in the eyes of the beholder
My grandfather had a desk drawer for receivables and another for payables. At any given time if the payable drawer was empty and there was money in the bank, then he knew he was making money. That would constitute the simplest form of cash accounting, but probably more accurately reflects cash flow. Since then we’ve come a long way and we still have a ways to go.
Not so long ago we saw large companies go from triple A ratings to bankruptcy in little more than a heart beat…remember Enron, WorldCom, Lehman Brothers, and the old General Motors Corp. If we learned anything it was that financial accounting is as much of an art form as it was an accurate statement of financial health.
Accounting for how much money was made in order to pay taxes, make distributions or reinvestments is the ultimate goal. The year-end Income Statement line Net Profit (before taxes) becomes the definitive report card. However, if that is an art form, then beauty is in the eyes of the beholder!
Computers make accounting more meaningful
The computer age has brought vast new dimensions to accounting. It has allowed faster results and increased reporting. It has made sharing data easier and putting the data in useful timely reports as simple as pushing a button. Computers have both simplified and complicated the accounting function.
The accounting function of a business should measure more than profit and equity once a year. It should provide a service for management to help determine how money was made and how equity can be increased. Building an accounting system to aid management in good decision making – and therefore good governance – is essential today. Regularly created financial statements reviewed by the management team will build more sustainable profit.
Danco’s commandment motioned “…make available the data therefrom to thy managers, advisers and directors.” Transparency! Family businesses tend to hold the financial information very close to the breast. My experience has been that if you don’t share the real data, then assumptions prevail based on observations and incomplete information. Those assumptions are hardly ever correct, but if you believe that perception is reality, then they become reality. Being transparent is critical. If you hide information, it is natural for others to wonder why.
Accounting’s rightful place
Accounting provides a critical ongoing function for the business to “do what it does” – whether it’s making something or providing a service. Accounting pays the bills and cuts the payroll. Accounting keeps the lights on! Yet, so often the accounting department is minimized, the CFO is housed outside the E-suite, and the department employees are the lowest paid. In many family firms the first key outside employee is the comptroller – probably because the position isn’t seen as critical as other roles filled by family. If your firm fits that model, I suggest that you rethink what’s really important. Who watches over the money is more than critical, it is decisive.
During the accounting period, the staff makes things happen just like the production folks. Their work culminates in the financial statements. Every piece of paper accounting handles winds up on the Income Statement or Balance Sheet somehow. Financial Statements provide a historical view of performance. They are vetted by a CPA, used for taxes, required by lenders and measure all critical components of the entity.
Managing your business
However, Financial Statements are historical information. They measure things that happened over a period of time, or provide a snapshot in time of a position. Strategic managers find a way to “read the tea leaves” and use the historical data to predict the future so that they can react in a timely fashion.
Focusing on trends can be a key. Watching gross profit percentage, focus on contribution margins or tracking meaningful ratios can all add to current decision making. Accurate cost accounting can let you know where you are really making money, and where things aren’t going so well. Having line percentages, years side-by-side, and/or several months at a glance can show you issues like a CSI finding blood with UV light. Getting that kind of data in a timely, easy to use format can make the difference between a good year or explaining why the bleeding began.
Here are some things you might look at:
- Realize that management accounting is very different than tax accounting, and if your company isn’t really doing management accounting, start tomorrow.
- Ask your CPA if he can compare your year-end statements with some kind of industry standard to see how you stack up.
- Think about data that would help you make better decisions and pursue finding it.
- Share key information with your managers, advisers and directors.
- Treat your accounting department with the respect it deserves and expect good accounting to help you make more money.
If you don’t have the staff and/or talent in house, there are outside CFO services ready to help.