How Finance Leaders Collaborate With Their Owners to Grow and Scale the Business

by Timothy D. Christ

Four key areas that contribute to profit leakage in every business.

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Building a business is just like building a house. When you graduate college, you build yourself a little 700 sq. ft. house. You get married and you add on another 1,000 sq. ft. You have kids so you add on another 1,300 sq. ft. You then enjoy the house for 10-15 years. 

If you were then to design a 3,000 sq. ft. house from scratch, the design would always look differently than what your current “added on” home looks like. The exact same thing happens in business. Due to cash flow restraints, the people you hire, market pressures, the products/services you choose to go with over time, etc., all contribute to how you add on to your business over time. What you end up with and the way that it functions, determines its operational efficiency.

There are four key areas that contribute to profit leakage in every business: operational efficiency, organizational engineering, profit engineering, and business development.    

With regard to profit engineering, 90%+ of small businesses are GREATLY underserved in the area of finance and accounting. If you are not having your accountant provide you with the ratios we talked about in the Fractional CFO chapter, in addition to your month-end, quarter-end, year-end financials, then have them start doing so immediately.  Bookkeepers can do the data entry, A/P, payroll, etc. However, few bookkeepers are able to create financial statements with the appropriate accrual adjustments made monthly. 

Reviewing the numbers in a business is just like going to a doctor for a physical. The doctor doesn’t need to see you for an entire year, but he can look at a chart of all your results and tell you exactly what is going on in your body. Your weight, cholesterol level, triglycerides, blood pressure, etc. The ironic thing about the doctor example is that in most small businesses, he would need to take all your vitals, and then call you back 2+ weeks later. Most small businesses take 2 weeks or more to close month-end books, so they are always looking at numbers from the past. The doctor wants to see your numbers that day, and business owners should demand real-time data in the form of easy-to-understand dashboards from their accounting department.

The numbers always tell a story. What is sad is that most small business owners don’t know how to get the numbers out of their business and then to interpret them so that they know what they mean. Most small businesses use checkbook accounting methods. Do I have money in the bank to pay for the bills that are currently due? All businesses are much better served by the use of true operating budgets, where you can forecast (accurately) your cash position three months’ in advance and you can make strategic decisions on a go-forward basis, instead of looking in the rear-view mirror to see how you ended up.  

Operational efficiencies, organizational engineering, profit engineering, and business development are examples of “Best Practice Cornerstones” for any business. They are not unique in any way, shape, or form, to an industry or company.  Their application to a company is unique, but they are absolutely required if that business is going to achieve higher levels of success.  

The challenge for most small business owners is they really don’t understand all that goes on within each department, so they are not able to provide any strategic leadership on how to “improve operations.” For example, with accounting, all they know is their accounting people work long hours and it takes them 2 weeks or more to close the books. The graph below from McKinsey is part of a white paper that explains that 61% of the activities within an accounting department are either “fully automatable (42%) or “mostly automatable” (19%).

Graph courtesy of McKinsey & Co.

Below is a case study to illustrate this point:

Texas Direct Auto is a large used car sales operation in Houston, TX that was using QuickBooks. They had grown substantially and had an accounting department of 25 people. It took them over 2 months to close month-end books and another month to provide department-level financial reports. This means that their management team was making decisions based upon data that was 90 days old. A decision was made to invest in a mid-market accounting system. The management team chose Microsoft Dynamics GP product. Once the system was implemented, their accounting staff went from 25 people to 3. The company continued to grow, and its sales volume tripled. The accounting department, due to the automation it now had, only added one person. When you calculate the labor cost savings annually, it was $1.2 million. Considering the one-time investment of $200,000 and an annual investment of about $50,000 means they saved $1 million in year one and are saving $1,150,000 annually. This doesn’t take into account the 1-3% net profit improvement that you get when you implement true operating budgets and give your department leaders real-time data for decision-making. 

In the above case, how can an owner improve the Accounting Department’s operational efficiency? He has to bring in outside expertise to review their current setup and see if there are any way to become more efficient. Since almost every department has plenty of work to do, rarely are the department leaders thinking about how to “re-design” their department. They are simply focused on trying to get the work done. This is not simply an accounting issue. The same exact challenge happens for IT, HR, Sales, Service, Production, etc.

When you take the owner and his leadership team “out of the fire” and think about how to re-design their house on purpose, the owner’s desired outcomes are (almost) always the same:

  1. Process-based system that is fully integrated, standardized, and aligned
  2. Real-time reporting of financial data, or as close as is possible
  3. Ability to forecast and develop detailed budgets
  4. User-friendly system with fewer manual processes
  5. Improved communication with customers and vendors

A few common frustrations with QuickBooks include the following:

  • Lack of full audit capabilities. Obviously, the larger you get, the more important this becomes. Knowing that you never actually “close” a period or “lock down data” means you have elevated risk within your organization. With the 30% of small businesses that have misappropriation of funds, it is because of the security gaps that exist in QB and a savvy accountant or operations person has figured out a way to game the system. Its ease of use means that several safeguards and security protocols built into more robust products simply doesn’t exist.
  • Cumbersome multi-entity management. Once a business has multiple locations and manages expense/overhead allocation between each location, means they must create duplicate journal entries in QB. If they have 8 locations and a utility bill, it can mean inputting that same bill 9 times, one for each company and then a 9th time to pay it from the operating account.
  • Most QB users rely on external (sometimes incredibly sophisticated) Excel spreadsheets to handle several accounting processes. As we are well-aware, these are prone to manual errors, and whenever a formula breaks, it is incredibly time-consuming to fix it. Most, if not all, consolidations/reconciliations should be able to be handled within your Accounting software/ERP system.

A strategically-minded owner, based on the above graph, will ask the question: At our current size/scope and with an idea of where I want this company to be in 5 years, what level of automation is appropriate at this stage of my business?

The challenge is that his Controller/Accountant will not be able to answer that. His CPA will not be able to answer that. His IT person will not be able to answer that. To answer this question, the owner must seek out an Enterprise Resource Planning (ERP) expert.

ERP’s by themselves do not make you money. However, the ability to automate many common data entry processes, such as A/P, payroll, and billing, can save significant labor hours. They are a sophisticated measurement tool in order to provide transparency and visibility into your now complicated company, with many systems and processes. It helps you identify where your bottlenecks are, helps you to better track and manage resources, and is simply the primary tool by which you get information about your company. The right ERP is highly scalable, which means adding 10 more locations, 500 more people, or another 1,000 customers do not “stress” the system.

I believe that ERP systems no longer stand for Enterprise Resource Planning, but rather, Engineering Real Profit for client companies, and hence, the title of my book. Designing a thoughtful, integrated, and size-specific solution for a client provides incredible value for a mid-market company. It helps eliminate several inefficiencies that have been created by their initial growth to $10 million, can successfully combat the organizational inertia that has crept in, and help them scale into the future.

Timothy D. Christ, M.B.A. authored the book: Outgrowing QuickBooks: Engineering Real Profit in Companies $10 Mil-$50 Mil.