You take the left, I’ll take the right

I recently finished re-reading Michael Gerber’s “The E-Myth Revisited”.  It is one of my go-to books whenever I find an organization that appears to be dysfunctional.  I find myself using parts of his model on my own organizations – since typically professional firms believe everyone should do everything.  This isn’t to knock professional firms but this approach is the single biggest obstacle to healthy and effective growth that I know.

“You take corporations and I take LLC’s”, seems like a great business model for accountants but it is simply a permutation of the “You take the left and I take the right” approach to management.  It doesn’t address the actual needs of the business and it doesn’t leave room for growth.  How do you hire an employee to fit that sort of arrangement?

It is even worse for other types of businesses.  I have worked hard to try and straighten out small businesses who grew into a disaster.  It is in those instances that I find comfort in the E-Myth; technicians who didn’t want to work for a boss suddenly have the worst boss in the world and so do his 12 employees.  All of whom are stepping on each other, tripping over inventory, losing tools, upsetting customers and generally eating up profits.

And in the meantime the owner is working 14-16 hours a day 7 days a week. Until he collapses.  What was the owner doing in those hours?  Everyone else’s job.

Organization, structure, discipline are tough to live with.  I get it.  As Mr. Gerber implies, you start your business because you want to simply work – you want a job.  You want to do it your way, meeting your customers needs by you always being available.  And, as he points out, it can’t work.  You simply don’t know it yet.

The problem is inertia.  Actually, that isn’t true.  The problem is the owner-technician’s inertia.  Try to take the owner out of the picture and you are accused of planning a mutiny.  Never mind the reality that the owner has already lost control; he talked to a friend who had a buddy who hired a consultant and that consultant ended up buying the company for almost nothing.  Never mind the reality that a company built around the owner is worth almost nothing.

Are you looking at a situation like that?  Are you the sole owner-technician of a small business where it seems that you re-do everything your employees already did?  Do you feel you are the only person qualified to make a sales call?  To build the widget?  To make a collection call?

Perhaps you are in a partnership and hoped that by making your best friend/employee an owner she would work 140 hours a week just like you?  Re-doing everything someone else already did, calling the same customers, shipping extra widgets…

This is where I depart from the E-Myth.  The author makes it sound like you can be down this path and somehow recover.  Sorry, it simply isn’t going to work that way.  Inertia is working against you.

Think about it.  You hired a bookkeeper because you hated doing the books and it ate into the time to make a sales call and build the product.  You still hate doing the books plus you don’t know how.  And if you do the books who will make the sales calls?  And don’t even get you started on sales people:  They make deals that you can’t keep and then they leave and take the customer.  No, it is better if you keep things they way they are and just work harder, right?

No.  It is not better; not for you, not your business, not your employees.  You can make the change but you can’t fight the inertia.  You may, however, be able to start deflecting your path.  The goal is not to slow you down but rather start changing the direction so that you start going in the direction you want.

More on this in my next article.  Have a great day.

Complexity

The past 10 days has seen us dealing with a lot of challenges which come about through complex entities trying to be simple.  Most of the challenges come from participants claiming they don’t understand but in reality it is they don’t want to pay the underlying cost of their organization structure.

The condominium association where the board didn’t want to address the interest charges to owners for financing a special assessment over 10 years.  Their stated argument was that they were trying to keep it simple.  The real issue was that they didn’t want to pay a manager or accountant money to track the owner accounts.  Eight years later, they need to perform a new special assessment to come up with the shortfall that is owed the bank.  This is going to be complex.

The investment partnership which wants to shift income between partners.  They crafted a simple partnership agreement and right from the beginning started doing this.  In the beginning they had lots of equity so the tax preparer was not worried about the unequal distributions.  Five years later six of eight members have negative capital accounts and it needs to be fixed.  They created a complex structure and thought a simple partnership agreement would allow them to do what they wanted.  They didn’t understand.   The truth is they didn’t want to pay someone to manage the complex modeling of the cash flow reallocation to ensure it was done correctly.  It is their profit after all.

The Corporation who borrows money from the bank and then retires their majority shareholder.  They write an agreement which says that the Company will repurchase 1/10th of the shares every year for the next 10 years.  At a stated price.  And then they fire the accountant who tells them they need to record a $5.0 Million debt – which of course puts them out of compliance with the bank.  They find a more accommodating CPA to prepare the financial statement.  Bank still finds out and calls the bank loans.  They didn’t understand GAAP.  No, the didn’t want to pay for effective advice.

Complexity has a price.  If you don’t want to pay higher prices, keep it simple.  There are no rules which say that profit can’t be distributed equally amongst all partners.  Shockingly  simple.  There is no rule which says you can’t buy back the owners shares.  But you should probably discuss that with the bank before you borrow money.  And then talk with someone who knows what GAAP might have to say about that kind of transaction.

The old adage is very true: Pay me now or pay me more later.  Alright I confess I added the more but it should have always been there.  It is never cheaper to fix the problem later.  NEVER.

There is another old saying: Accountants have the magic wand and attorneys have the way back machine.  Notice though that you have to go to the true wizards of Oz to fix the problem.  Accountant’s to create the numbers to correct the problem you created and the attorney to create the right paperwork at the right time.  In hindsight.

Today is about clichés apparently.  I believe it was Einstein who said, “A problem can never be solved by the same intellect which created it.” or something to that effect.  What this means, in my world, is that the client goes to one accountant and lawyer to “be simple” and then fires them to find someone to fix the “complexity”.  That means coming up to speed, understanding what you originally did, and then trying brainstorming for hours trying to come up with a plausible solution.

Yes, there is a better way.  Plan for complexity.  Accept that some modes of transacting business require new, or at least different, processes.  Maybe new software; perhaps a new department; perhaps a new legal structure.

The entities above each spent under $2,500 to create the original simple way they wanted.  Each has to be in excess of $20,000 to fix the problem.  I don’t think planning to deal with complexity right up front would have cost anywhere near the cost to fix it.

Complexity.  You will pay for it.  The smarter play is to accept it upfront and make it a cost of being in business.  Or don’t.  You simply pay more to fix it.

Have a great weekend.

Accounting Standards

One of the big issues we face, as auditors, is an entity following an accounting standard for its financial statements.  Which begs the question, what is an accounting standard?

The best way to look at it is that an accounting standard is the expectation of how transactions should be recorded and disclosed in financial statements.   For generally accepted accounting principles, also called GAAP, this way of recording and reporting transactions is presented in the Accounting Standards Codification, or ASC’s.

Why should anyone care?  That is the question we are struggling with this week.  It seems that there are some, even in professional accounting, who are unsure why GAAP should be followed.  I have shared with you some of our more interesting conversation with clients and their management but we have similar discussions within the profession.

The simplest answer is, eliminating confusion.

GAAP, with all its faults, is just what it says it is, generally accepted.  This doesn’t mean universally accepted but it does mean that most of us agree that transactions should be recorded and reported a particular way.  By agreeing, up front, on how transactions should be completed, we get rid of the guesswork and the uncertainty of everyone deciding on their own.

Yes, this is all wonderfully theoretical but the vast majority of small businesses, non-profits and HOA’s don’t care about GAAP, is the argument we hear.  No doubt.  But the people who put their money into it should.

On a simple level, you are approach by a friend, a contractor lets say.  He wants you to be a guarantor on a project.  It seems he can’t get bonding.  You agree but only if you look at his financial statements so you know what you might be getting into.

He hands you a single piece of paper.  On it it says,

Cash        $500,000
A/R       $2,500,000
Profits                 $3,000,000

Are you ready to sign on the dotted line to guarantee this upcoming project?  If so, please write me immediately because I have an investment idea for you!

Of course you are not going to accept it.  Not because you question the numbers, per se, but because you don’t understand how they came into being.  In short, this is confusing isn’t it?

What would you like to know?  How about how he decides to recognize his income?  Perhaps how he elects to record expenses?  Does he have any debts that are not on the books?

You are interested in his accounting principles.  Now, if you happen to know how most (not all) contractors do accounting, you could ask something like,

Other contractors I know record revenues based on how much of the work is completed, is that how you record it?  I have read several other financial statements from contractors and they all have some amount of construction costs, how do you record costs?

If everyone could pick and choose the policy they want to follow we don’t have standards.  You would not have an ability to compare one company against another in the exact same industry – you would not even be able to follow a single company from year-to-year.  Accounting standards enable you to do this.

Look, we know GAAP can be complex.  But in all fairness, your entity is complex.  If you are a retailer of candy bars and you sell for cash only, you have very simple accounting.  If you take money today for work that will be done over the next three years, you created complexity.  And if you do work today and allow people to pay you over the next three years but only in relationship to how effective your work is, you created a nightmare.

As a reader, you should want to know how an entity records and reports transactions.  You should want to feel comfortable that a lot of other similar entities are doing the same thing.  In short, you want to feel good that the financial statements you are looking at are, in fact, generally accepted.

If you don’t like GAAP, then don’t play with other people’s money.   Don’t ask lenders, don’t ask investors, don’t ask me.  If you are the only person who relies upon how you do the accounting do it any damn way you please.  I mean, lets be honest, you won’t even look at a financial statement.  You will log into your bank to see how much cash you have and make all your decisions based on that.

But if you expect others to put their faith in you, then embrace GAAP.  Ensure you prepare financial statements for them to read that comply with the standards the accounting profession has provided.  The standards don’t exist to make your life miserable, they exist to help you get the funding you need.  Overwhelm your reader with good, actionable information and they will return the love.  They may not give you money, but they will likely do what they can to help you succeed.

Because honesty and integrity are still rewarded in this world, even if it often doesn’t seem like it.

Have a great weekend.  And if you are looking for an auditor or CPA firm to review your financial statements, or just help you make sure your financial statements are useful to your readers, feel free to get more information and contact us through our website.  We are here to help you rely upon your management, even if that is you.

 

Understanding risk

We were asked to propose on a review engagement about 10 days ago.  This is for a commercial business doing about $20 million in revenue.  Their prior accountant got out of doing attest work – it seems the peer review burden and trying to stay in compliance with the standards was more than he wanted to undertake.

We asked for and received copies of their past two year financial statements as well as their interim statements.

  • Significant losses in 2015
  • Significant losses in 2016
  • Significant profits in 2017

We started asking some high level questions of the controller and her response bothered us.  She started by asking if we were accusing her of “cooking the books”.

If you own a business, or are the responsible accounting person, you need to understand how this goes.  It is all about risk and from the independent accountant’s perspective, the risk is based on who reads your financial statement – so our job (in a review) is to make sure that nothing comes to our attention to make us think the financial statements are not correct.

When we see a pattern like this, we are skeptical.  Believe it or not, skepticism is a job requirement.  The code of professional conduct requires us to be skeptical.  But skepticism is not cynicism and automatically assuming the worse, it is thinking that maybe something is overlooked.

Imagine your teen brings home 2 progress reports in a row which say that homework is not being turned in.  You walk into his room while he is playing video games and ask if he completed his homework.  He says “Yeah of course.”

It isn’t that you don’t believe him.  But lets face it, history isn’t kind and he does have a track record of not doing it.  So what do you do?

Ask if you can see it of course.  You are skeptical.  You are not accusing him of not doing it, you are simply verifying that it is complete and ready to be turned in.

If it is done, great!  Pat on the head and maybe even a hint on how to beat the level.  If it isn’t, well I wouldn’t say he lied, I would say that no doubt the game is interfering with his memory and say that perhaps it is better off in your closet.  Until his memory improves and the homework is done.

It’s a silly analogy but true.  As the independent accountant, we are concerned with risk.  Risk to ourselves naturally, but also the risk that might be taken by the reader of the financial statement if it turns out it isn’t accurate.  We are proud of our independence and objectivity.  And this requires us to ask questions which make people uncomfortable.

Keep in mind, most of us who still perform attest services have seen a thing or two, so we know a thing or two. (Sorry Farmers, I owe you two cents) We realize that the bank is probably paying very close attention to your numbers.  We are pretty certain that another year of losses could end up with you in special assets.  We know that some peoples jobs are potentially on the hook if profits don’t improve.

We have seen it before.  But it isn’t cynicism, it is skepticism.  The patterns are there so we have to reduce the risk that the pattern is real.  And we do this by asking questions.  Sometimes painful questions.

We have to learn your business, your processes.  We have to understand the industry you compete in and sometimes the multiple industries you try to make a profit in.  We have to know what others in your industry do when it comes to capitalizing assets and recording liabilities.  We have to understand your motivation and tolerance for risky behavior.

Keep this in mind when your independent accountant starts asking questions.  And, if your accountant isn’t asking questions, maybe it is time for you to get another accountant.

Have a great day.  If you have a need for an audit or review in Washington or Oregon, feel free to learn more about us on our website and contact us for more information.  We are here to be of service to you.