NOT what you think!
If you had to guess the most common reason businesses don’t make it, what would you answer?
You’ve probably heard many of the common answers – cash flow being the most commonly cited reason. Based on real world observation I have categorized the common culprits as cash flow, compliance, and catastrophic decisions made by operators (I call these the Three Deadly Cs). But all of those actually share a common foundation. What is it?
Drumroll … bad accounting is the root cause of all of these almost every time in my experience.
“Really?! Accounting?! That seems a stretch” – you might say. Let me show you why – and how to avoid it, by looking at the Three Deadly Cs in turn.
The most common immediate cause of business shut down statistically is insufficient cash. Why does this happen? It can happen because of inability to accurately gauge future cash demands and inflows. This is actually a direct result of an inadequate accounting system or process. Good accounting allows you to anticipate cash needs as well as how much “buffer” you actually have. Ignore at your own peril.
Many times cash flow issues arise as a result of not really knowing profit margin levels or revenue trends, usually because the books are way behind. Sometimes it happens because of not understanding tax liabilities, or being out of compliance and incurring large unforeseen penalties.
Again, these are all accounting system issues. My argument has always been that cash flow is s symptom, not a problem. Good accounting helps you find the problem, and likely avoid it in the first place.
Employee and tax related compliance issues are high on the list of unplanned business shut downs. Additionally, unplanned work comp costs or local regulatory and licensing issues are common. If you have to suspend operations, your overhead continues while your revenue dries up. Most businesses can’t survive this. But why does it happen?
Not including compliance costs in budgeting is one of the most common reasons for violations. Often this is a situation of you don’t know what you don’t know and not getting the proper input before starting or in early stages. It results in saving a dime to spend a dollar. Not a great strategy. A good accountant will know enough to at least ask all the right questions and identify items you may not have been aware of on your own.
I have seen business owners make decisions about expansion, major purchases, a change in business model or types of service offered/ revenue sources without really having the data to evaluate the decision. Sometimes a business will increase marketing activity for a certain service without really understanding the profitability and cash demands related to providing that service.
This can lead to over-extension of debt, dangerously high increased cash demands, and other risks that are new to the business. Increasing revenue does not always actually benefit a business!
If you are not doing cost-volume-profit analyses or if you don’t have a good way to capture and measure the success of a change of strategy, you are better off fixing that first. Again, all of this depends entirely on an accurate, current, and robust accounting system that is designed to do more than spit out an after-the-fact profit & loss statement.
What does “Good Accounting” look like?
How do you avoid these pitfalls? What does an effective accounting system look like? Here are some generalizations, but understand that when I am working with a client to set up or revamp a system, individual circumstances and needs drive how we proceed.
Simple as Possible
An effective system is not going to be more complex to use than absolutely necessary. Why? If it is too cumbersome, it won’t be used consistently or correctly. I always evaluate both the desired capability of the system as well as the availability and capabilities of the people who will use it. It does no good to have the power of a supercar if it doesn’t have an Autobahn.
Good Audit Trail
Many software platforms now give the ability to attach actual documents to various transactions. Your physical documentation and data process needs to be robust enough for you to detect and avoid theft and loss, as well as support external audits by the IRS or others.
The type and complexity of desired reports depends on the needs of the business operators. While simplicity is a good goal, there is such a thing as too simple. For example, a contractor should only use a system that has the ability to create job-costing reports (without creating too many redundant processes). Anything less and the owner does not have the visibility to understand profits and cash demands, which leads to … catastrophic decisions.
Your accounting system should provide you the ability to use historic data and current plans to create budgets. At minimum you need a profit budget and a cash budget with the ability to do a variance analysis. This allows you to evaluate performance and find operational causes of variances from plan. If you are not forward-looking, you are getting minimal benefit from your system. Accounting can do way more than help you file tax returns! Don’t settle for less.
Asset and Debt Management
This matters especially if you deal substantially in receivables and payables. It’s not just about your software structure, but also your internal staffing and processes. Timely entry, the ability to run helpful reports, and the processes to respond appropriately will help you collect faster and manage cash flow well.
Those general guidelines will help you create a system that helps you run your business with better real-time insight. This will in turn help you anticipate needs and avoid disaster that could be life-threatening for your venture.
It does not have to cost an arm and a leg to implement – but keep in mind the accounting system is your backbone – it will make or break you. Make sure you are prioritizing it accordingly, and the associated costs will more than pay for themselves in the dividends that follow smart decisions and costs avoided.
In your corner,