5 Basic Accounting Principles Most Entrepreneurs Get Wrong

For most entrepreneurs, fast growth is the ultimate goal. Many start off with a great idea, hobby, side hustle, or like a lot of folks in the past year, enough free time to think, “what if?”. Then suddenly that fledgling business takes off and the business owner is struggling to keep up with the growth. If this dilemma sounds all too familiar, here are five basic accounting principles to help manage a fast-growing company.

1. Create a budget.

We are always surprised at how many successful, profitable companies have done it without any budgeting. We wonder how much more profitable and successful these businesses would be if they set revenue goals, created spending limits, and gross profit percentage requirements. No one would set out on an interstate trip without consulting a map or bringing up Waze on their phone but each year thousands of business owners don’t take the time or require their accounting team to develop an annual budget.

2. Understand cash flow.

All too often business owners manage by gut feel and think as long as they see profits, all is good. Time and time again, we’ve seen profitable businesses stall because of a lack of cash flow. Cash is the lifeblood of any business and is not always tied to profits. The symptoms may not point directly to cash flow issues, but a trained CFO can spot them rather quickly. Things like past due A/R balances, reliance on factoring, maxed out lines of credit or using non-traditional, high interest funding sources (Kabbage or Funding Circle for example), or slow inventory turns are prime examples of poor cash flow. Most times it’s a combination of things that create the cash flow crunch. One client we helped had reasonable A/R balances, slightly high inventory, and some inefficient office practices. Nothing stood out but our intuition told us to dig further. Upon examination we realized that they often took a week or two to record inventory purchases, the same week or two “grace- period” to invoice customers, and then routinely let customers pay around the 45-day mark. When added together, the cash cycle was 75-90 days! Some simple improvements and better practices shortened this to 45-60 and the cash started flowing.

3. Evaluate equipment purchases based on numbers, not intuition.

The goal of any business owner should be to maximize the earning potential of any asset. As a contractor once told me, “If it ain’t pumping black smoke, it ain’t makin’ money.” True indeed. Too often we see business owners buy the latest and newest items for tax reasons, pride, or any other reason. Some of the most profitable companies use old equipment that is well maintained and paid off. Higher growth companies need to finance their equipment to preserve cash. The key is to have a plan and be sure that any addition to the fleet is going to generate the ROI needed to justify it. We recommend renting when able to evaluate both the performance and judge the true business need of that asset. Finally, take the time to calculate the revenue increase or amount of business required to justify the investment in the new purchase.

4. Plan for the costs of employees

Let’s face it, employees are expensive. They want to get paid at or above market, they expect benefits, fun events, need computers or equipment and let’s not get started about the government taxes or the paperwork. Human capital often makes up 50-60% of the average company’s entire operating expenditures. For this reason, it is crucial to plan out when employees are going to be added, what their roles will be, and what revenue they are expected to generate. At Lucrum we know how many billable hours each employee should generate, what revenue that equates to, and that helps us set pay scales. We also do annual compensation summaries to add up all the costs and benefits that each employee receives by being part of our team. We recommend clients do the same to ensure both sides understand that that position costs.

5. Seek outside financial help.

Most business owners don’t have a background in finance or accounting. And even those that do, it’s probably not the best use of their time. Generally, owners need to be focused on running their business, selling, or delivering the products/services. What might have worked during the start-up phase probably won’t work when the business reaches $1, $5, or $10 million range. If preparing financial reports, doing cost benefit analysis, or researching discrepancies aren’t the best use of a business owner’s time, it’s probably a smart decision to get help. This can be a full or part-time employee or a contractor. Some CPA firms do bookkeeping work, others offer CFO services. Still other firms like Lucrum specialize in outsourced accounting and leave the tax/audit work to the CPA’s. Regardless of who you choose, make sure to hire a quality provider who is a good fit both from a personality and a financial outlook perspective.

Focusing on these five areas should help entrepreneurs manage the aggressive growth they strive for. Business owners have enough risk and uncertainty; most of these recommendations seek to reduce that risk and provide some stability and ensure all decisions are made based on quantitative analysis. If your business is struggling or you are finding it difficult to keep up with the growth, give Lucrum a call; one of our experts is happy to help get your business back on track.