Category: Accounting

Marketing Expenses

~ C.O.R.E. Beliefs ~ Leave a comment

Happy Monday everyone.

On Saturday, Kubae and I went into Portland for an Urban Hike.  In all, we put in almost 10 miles (granted over 6 hours) and enjoyed an almost car-free downtown experience.

We even caught part of the Rose Parade, but mostly walked the Pearl District with brunch at the Brunchbox – Monte Cristo sandwich and late lunch at the Upper Deck on 13th.  For lunch we split the Fenway Club (which was smart because it was enormous) and lots and lots of fries.

I really enjoy our urban explorations, especially when a city is kind enough to shutdown auto traffic.

In my years of practice, I have discovered that, for the most part, small business owners have been slow to embrace marketing as a means to growing their business.  My observation is that there are two areas of the business which are typically thought about at the last minute when the owner strikes out on his own – accounting and marketing.  I think this is because these are the two areas they were not exposed to in the previous position when they got the idea to go into business.  These are also the two areas that protect the process – the business as you see it – by generating interest in your offering and then making sure that you are profitable.

There is the old saying, “You can lead a horse to water, but you can’t make it drink.”  But what if you had along a “Horse Whisperer”, whose sole job was to constantly whisper into the horses ear – in horse language – “You are thirsty, you are thirsty, you are thirsty…”  I think that by the time the horse was lead to water, it would be extremely difficult to get your horse to stop drinking!

This is the essence of marketing.  Marketing is all about building awareness of your business; what you offer and how customers can buy.  This should not be confused with the act of closing the deal – the sale.  Marketing gets prospects in the door and sales does the easy part… provided that your sales message supported all the marketing you have done.

Marketing is the front end of your business.  It is the telephone, your website, your email address.   It is about how your business looks when a customer walks in the door.  10,000 things that come together to present your business.  Marketing is all the things that give your prospects and returning customers that feeling you totally understand his situation and offer the right solution.

When it comes to marketing, think bigger picture.  Ask yourself how prospects look for products/services you offer?  Do they ask a friend or perhaps another trusted advisor?  Is your prospects first stop Google?  In today’s fast-paced world, you should consider that most new prospects and repeat customers, are going to search you on the internet so you need to be ready for that.

Since we are now at mid-year for most small businesses, I would encourage you to start your budgeting process for next year.  I know, no one likes to budget but it can really help you determine how your limited resources are going to be put to use in growing your business profitably.  By looking hard at what you have and what you want, you can start making better decisions about how you spend money to get the business you want.

Some things to consider:

  • The demographic of your target customer
  • What your target customer likes and dislikes
  • How they find a solution to a potential problem
  • Internet presence and searchability
  • Company phone number versus cell number
  • Email (domain) address – no Yahoo, Hotmail, or Google.
  • 800 number
  • Printed materials
  • Time

Put values on these items, both their cost and their potential revenue.  Be conservative on both sides.  The low dollar investment with high potential pay-out might likely be the area you want to invest your money in to generate new prospects.  But no matter how you want to invest in your marketing, you will definitely want to find measurements that help you know if your investment is working like you planned.

I strongly encourage you to work with your accounting professional and perhaps even a marketing consultant if you have questions.  Remember, your accounting firm’s Principals and Partners have many years of experience marketing and developing their business and can be a very useful resource for you.  And if you would like to have a second opinion or are looking for an Accounting firm that knows small business, feel free to contact us at Currie & McLain.  We would be happy to sit down with you for a free no obligation consultation about your business and how you might find ways to grow profitably.

 

Important Ratios for Your Busines

~ C.O.R.E. Beliefs ~ 1 Comment

Happy Friday.   In only a few hours, it is time for some Pinot Noir, rib eye, more Pinot, and perhaps a little Royal Painz.  I didn’t think I would like the show (it’s on Netflix) but if you would like to see a MacGuyver-esque doctor who makes housecalls, you may enjoy it. It is also Rose Parade weekend in Portland!   What plans do you have for this fun weekend?

I think a big part of why I enjoy accounting is that I get to see so many different things and work with so many different clients.  Each client is unique and yet so very much like every other business:

They have a “goal of making money now and into the future.” (the Goal by Eliyahu Goldratt).

Making money is the primary reason for being in business because at the end of the day, the Company must pay its bills and provide a return to the owners.  Anything less leads to the failure of the business.

I enjoy helping small business owners find ways to monitor how well they are doing in relationship to their goals and one area we spend quite a bit of time on is building key ratios and graphing them.  I then teach and help the small business owner’s staff complete the ratio worksheets and help explain what is shown on the graphs.

Below are a few of the ratios I think are very helpful to most small businesses:

  • Gross Profit per Labor Hour
  • Marketing Expense per New Customer
  • Website hits per New Customer
  • Website hits per Business Inquiry

Some of the ratios above are lagging indicators and some are leading – meaning that some measure how well the business performs (lagging) and some measure how new business comes in (leading).   Having a good mix of these measurements allows you to know quickly if your business is on track.

Naturally, these ratios assume that your accounting is current and you have developed ways to track the non-accounting data.  It also is very helpful to set an expectation for your business so you know if everything is running smoothly or if adjustments need to be made.

Examining each ratio:

Gross Profit to Labor Hour

I like this ratio as it essentially turns every business into a “service business” by ignoring the Cost of Goods Sold.  Gross Profit in a manufacturing business is essentially the amount of revenue available to pay the business and operating expenses.  By starting the calculation with Gross Profit instead of Total Revenues, you can measure the impact of your labor on generating the money to pay the bills and earn a profit.

Marketing Expense per New Customer

This ratio helps you understand what it costs you to attract a new customer to your business.  If you are spending $10,000 per month on marketing and attract on average 4 new customers, then the marketing expense per new customer is $2,500.  By knowing what the lifetime value of a customer, you can begin to ask if we are getting enough new business in the door and if we are effectively closing sales.

Website Hits per New Customer

As you transition your marketing efforts to online, this becomes a very important indicator of your marketing performance.  How many people come to your website and how many ultimately do business with you measures your site’s ability to educate and inform your prospects.

Website Hits per Business Inquiry

This ratio actually precedes the prior ratio by helping you examine your internet sales funnel at an earlier stage.  How many web hits actually end up with the reader clicking “I want to know more?”  You see that from this  initial click, the ratio Website Hits per New Customer has more meaning as  your chart can show the ratio between total page visits, total “interest” clicks and then number of new customers.

There are many different ratios that can help you manage your small business without having to get stuck in the details of your accounting system.  Talk with your accounting professional about ways to look at your business without having to interpret your financial statements and that can keep you focused on your Goal.  If you are not working with an accounting professional or would like to have a different set of eyes to help you, feel free to reach out to us at Currie & McLain.  We are happy to consult with you at no cost and no obligation and help you see your business in a new way.  And if you haven’t read the book, “The Goal” I highly recommend it.  It is a fun story, easy to read and provides new insight into other ways to manage your growing business.

 

 

Cost of Goods Sold

~ C.O.R.E. Beliefs ~ Leave a comment

Happy Tuesday.  Today I am having lunch with Delena Meyer of Way Enough Decision Coaching.  I was fortunate enough to work with her at my last Company where we had to work through some growing pains. For an Organization facing pressures (aren’t we all) it is worth bringing in an outside consultant to bring a different viewpoint and work with the management team to find ways to move forward together.  I will have more to write about Way Enough Decision Coaching tomorrow but I strongly recommend her if you want a coach who can cut to the chase.  Her number is 360.281.4743.  Give her a call and let her know you were referred by John.

Cost of Goods Sold

Inventory is typically the largest dollar value of current assets in many small businesses.  This is especially true in retail, wholesale, construction and manufacturing.  When goods are sold, the dollar value of the items is adjusted from inventory to cost of goods sold (CoGS).  Which by the way, typically means that cost of goods sold is the largest “expense” item on the Income Statement.

I can hear my editor now, “John, if it is such an important number, why aren’t you tracking it on the Dashboard?”

The answer is, of course, that we are tracking it – using the amount in Accounts Payable as a reasonable substitute.  The goods in a business are almost universally purchased on terms so a healthy business will typically have inventory approximately equal to the amounts owed vendors.

I will spend more time on inventory in a later blog post, but the big take-away for today is that CoGS represents a significant item and it is the largest opportunity for error and irregularity in small business.

A Client Story on CoGS

About 2009, the firm had a client, ABC (named changed to protect the innocent) which was a specialty manufacturer.  The Company had borrowed a substantial amount of money from the Bank and had also bought out a major shareholder and owed on a term note.  The Bank required ABC to have a reviewed financial statement.  The information below is what the financial statements reported each year.

2005 2006 2007
Inventory
Raw Material       5,000,000    5,500,000    5,200,000
WiP       2,000,000    1,800,000    1,600,000
Finished Goods       1,000,000    1,300,000    1,000,000
Total Inventory       8,000,000    8,600,000    7,800,000
Revenues      18,000,000  19,500,000  20,500,000
CoGS      14,000,000  15,400,000  16,500,000
Gross Profit       4,000,000    4,100,000    4,000,000
Profit Margin 22.2% 21.0% 19.5%
Net Profit      (2,500,000)   (2,750,000)   (1,500,000)

The 2008 Surprise Change to Cost of Goods

The client sent over their internal financial statements and trial balance in February 2009 showing the following information:

2007 2008
Inventory
Raw Material    5,200,000    6,000,000
WiP    1,600,000    1,750,000
Finished Goods    1,000,000    1,250,000
Total Inventory    7,800,000    9,000,000
Revenues  20,500,000  21,000,000
CoGS  16,500,000  14,500,000
Gross Profit    4,000,000    6,500,000
Profit Margin 19.5% 31.0%
Net Profit   (1,500,000)    1,250,000

The first thing the staff noticed was that CoGS dropped by $2,000,000.  When you look a little deeper, you realize that inventory increased by $1,200,000.  For the professional, this looks a little suspicious so we started digging.  By asking the following questions (and others) we discovered the truth.

  • How can sales remain flat while CoGS drops by 12%?  Is there a new customer willing to pay a hefty premium?
  • Did ABC stop what it was doing at the end of the year and physically count the inventory?  Who reviewed the count sheets?
  • What are 2009 sales projections for ABC?  Given that we are in a tight credit situation, will sales grow in excess of 20% over 2008 to justify the investment in inventory?

The answers we received sadly required the firm to withdraw from the engagement.  But the point of the story is that as a small business, you should ensure your management team is on top of things like Cost of Goods Sold.  The balance is potentially large, there are huge dollar amounts flowing through the account and a small change in the margins can impact your profitability – and potentially your banking relationship.

My recommendations for staying on top of your CoGS:

  1. Require a full physical inventory count at year-end.  No matter how good your accounting system, a physical count helps keep the computerized data synced.
  2. Review your gross profit margin monthly.  If you are averaging 40% gross profit and it suddenly dips to 30% for no reason, ask questions.  It may be legitimate, it could be a posting error, or it could be something like fraud.
  3. Go out and spot count a few high dollar inventory items and compare your count to the accounting system.  You doing it yourself will show your team how important you think inventory and CoGS is to your business.
  4. Don’t try to hide a business problem by adjusting your CoGS.  In the story, the business had to show a reasonable profit margin in 2008 or the bank was going to place ABC in Special Assets.  ABC still ended up in Special Assets. Also, the CFO was terminated, shareholder/manager compensation was reduced by 80% and the business could no longer pay the notes to the retired shareholders.  4 years later the Company was liquidated for about $0.15 cents on the dollar.  A few years later I ran into the banker and he said that the Bank may have been willing to work things out with ABC had they not tried to fool them. Sad.

If your business sells goods, your CoGS plays an important part of your profitability.  It is intimately tied to your inventory levels and can be challenging to stay on top of.  Knowing how CoGS is related to your revenues and feeds out of your inventory can help you grow profitably and with fewer headaches.  Talk with your accounting professional if you have questions or feel free to send me an email if you would like to discuss this article or anything else regarding your business.

Have a great day.

Accounting for Revenue

~ C.O.R.E. Beliefs ~ 1 Comment

Happy Monday!  I hope you enjoyed your weekend.  Here in Vancouver it was nice and warm, upper 90’s both days, and it was a weekend with the boys which made it even better.  Did you do anything fun?

Revenues in Small Business

The accounting for revenues in a small business can be a little tricky.  Depending on your industry, sending out an invoice does not automatically make the amount “revenues” under Generally Accepted Accounting Principles (GAAP).  However, for your purposes as the small business owner, sending out that invoice as early as possible can be extremely important for your cash flows.

The 3 Reasons Not to Record the Invoice as Revenue

Under GAAP, revenues and costs are supposed to be matched so that someone outside your business who reads your financial statements – such as your banker when you apply for a loan – can understand your costs in relation to your income.  But there are other reasons to consider not recording some invoices as revenues at the time of invoicing your customer.

  • The Invoice is for a Deposit on Work to be Completed Much Later

At my last Company, we often charged a deposit of 50% to secure time on the master schedule.  Since many of these projects were worth over $20,000, the plan was to ensure the Customer had “Skin in the Game”.  From a cash flow perspective, it was great to get the money in before we had to start ordering materials and parts.  From an accounting perspective, however, we faced several potential issues.

  • Customer wanted to cancel the work

Eventually, a customer cancels the work that they requested.  If you are lucky enough to have the customer cancel in the same month, then there is no problem as the receipt of the money and the repayment happens in the same month and they cancel each other out.  But what if the customer cancels 2 months later?  Your Income Statement looks odd as Month 1 reports all this income and then Month 2 shows either a negative income for that amount or you show some sort of discount or allowance or perhaps you have a refunds account.  If it is only you looking at the financial statement, then it is probably not a problem, but if you have someone like your banker or insurance agent looking, you have to explain, which may cause them to question your accounting. Plus, the risk is your Company spent the money and has to scramble to find funds to repay the deposit. 

  • Labor and materials are not being used on the project for 3-9 months

This is somewhat along the lines of what we discussed above.  In month 1 you record all your income and then month 4 you have all your expenses, you cannot really tell how well you are doing by looking at your financial statement.  If you are trying to run your Company by the numbers, this may cause you to think things are going well in Month 1 and not-so-well in Month 4.  By using some method for project accounting, you can see how well your projects are doing over time, but these will not roll-up to your Income Statement.

  • The Invoice is for Work to be Done Over Time

Think Ongoing Contract like in a gym membership.  Lets say you give your customer a chance to pay monthly or offer a discount to pay in advance for a whole year.  Those who take advantage of the discount are still going to use the gym (well potentially use the gym but that is a different matter) over the next 12 months.  To match up with the members who pay monthly, you may want to make sure that your accounting team keep a different schedule (perhaps in Excel) which tracks who has paid and the charge per month for the year.

Revenues in small business are not always easy.  If you are the only person who will ever look at your books, then you can keep them anyway you want and work with your outside accounting firm at year-end to get the numbers right for tax purposes.  There are benefits to running your books to record revenues when invoiced, but there are perhaps many challenges to this as well.  Talk with your accounting professional for advice on the best way for your business.

If you have questions and would like a free, no obligation consultation, write me using the contact form below and we can have a conversation about your concerns and how to address them.

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Have an awesome Monday.