What can a Controller do for your company?

Posted on September 16, 2011 by Jim Payne

The bigger your company gets, the less you can manage it through your presence and local knowledge. This means you will need new tools and techniques to be effective. Most of these tools revolve around financial and operations reports. The bottom line is that a couple of bookkeepers entering information in QuickBooks is not going to be adequate to get you where you want to go. You need a step-up and that step-up is someone into the position of Controller.

The controller is your first level of financial executive. This is something distinctly different from being a competent bookkeeper who may know a great deal about where to post a transaction entry. The controller can and must make management decisions that is well beyond what a bookkeeper would be comfortable making. If your controller is not making management decisions, then you have a bookkeeper in disguise and it is costing you dearly. The cost is the missed opportunity of being able to move your company to the next level from say a $10 million a year company to a $100 million a year company.

So just exactly what should you expect from your controller? Naturally, the first thing is an effective manager of the accounting department. This part is no different from any other department head in that they are accountable for what works and doesn’t work in their department. It’s the higher level functions that can really benefit the company by allowing it to grow without having continual information problems. These include:

  • Managing the cash flow.
  • Producing timely reports such as financial statements in a format that is useful to making management decisions.
  • Produce planning tools such as budgets and forecasts.
  • Perform analysis functions of management options such as the make/ buy or breakeven point analysis.
  • Review and contrast various insurance or employee benefit plan analysis.
  • Bank negotiations.
  • Coordinate with outside tax consultants.
  • Assist in the design of policies and procedures and take responsibility for implementation.
  • Sign various documents such as checks and tax returns.

Planning to do these functions with a bookkeeper level person is simply not going to work. Trying to grow without doing these things is also not going to work. To get where you want to go is going to require a financial executive on your management team.

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Using Activity Based Costing for Business Process Management

Posted on August 29, 2011 by Jim Payne

Activity Based Costing (ABC) made quite a splash in the 1980’s as the fad of the moment for business success. Its complexity made it too difficult and therefore expensive for most small businesses to implement. The result is that its space in the press and on the bookshelves was taken over by the next management fad in line.

ABC was designed to be a better methodology for assigning overhead costs to those activities that used them. The result was better information on what was driving costs and better decisions on how to manage them. ABC has had its most successful applications in the manufacturing sector for which good costing systems is a requirement for success.

But, is this all it should be used for? I think small businesses, particularly those that want to become a big business, are missing out on a great tool for managing their overhead costs. My conclusion is based on the following assertions:
1. Overhead costs are mostly the result of the repeating business processes, such as the cost of processing a purchase order.
2. Managing something is always easier if you can measure it.
3. The complexity of ABC as applied in the traditional manufacturing process can be modified to a much simpler approach if what you want to measure is business process output.

Most people will probably agree with the first two assertions. But, just how do you apply ABC to find out what business processes are costing? It starts with understanding what it is you would like to know from the accounting system. In the case of my business, one of the things I want to know is what is it costing me to market my firm on the web? I can’t look at my Profit & Loss Statement and see that answer pop out. The reason for that is the basic design of P&L statements which accumulates costs by their description rather than their use. The costs for web marketing crosses a lot of the expenses such as my time, fees paid to consultants, the expense of traveling to and participating in SEO seminars to name a few. To get the answer I am looking for requires a different approach to the accounting system.

I need to change my accounting system so I can relate the various costs of web marketing not only to the traditional accounts of salary, auto expense, etc., but also to the activity of web marketing itself. This can be accomplished by adding a lot more general ledger accounts so that instead of just one auto expense account, there is an auto expense account for each activity that might have auto costs. Then a special report can be called that will list each activity showing the costs by description for that activity. This sounds terribly hard to manage, but isn’t. We do all this stuff by computers today and they don’t really mind how many general ledger accounts there are. It’s a little more difficult for the bookkeepers because they have a lot more accounts to choose from when recording a transaction, but it’s not all that much harder.

Is it worth it? Now when I ask the question what my web marketing costs have been for the last three months vs. the previous year’s three months, I can get the answer by simply opening up

Posted in Business Ideas, Business Processes | Leave a comment

Using IRA’s to invest in Real Estate

Posted on August 18, 2011 by Jim Payne

I recently met a Real Estate Agent who was on his way to the coast to buy a rental property. Given the low prices and next to nothing interest rates, it is certainly a great time to invest in real estate. The imaginative thing about this guy’s plans was that he was going to buy it through his IRA account. I have seen this done before, at the height of the housing boom, and it hadn’t worked out that great. I continue to be less than enthused about this tax plan.

The only positive that I can think of for this approach is the possibility of generating a better return on your IRA investment. A knowledgeable real estate investor whose stock market expertise is limited to the latest and greatest mutual fund should certainly be able to produce a better return by sticking to real estate. This is the only plus that I can come up with that would suggest this might be a good idea.

There are a whole boat load of negatives:

  • Most real estate investments will produce tax loses while having positive cash flow. These loses are not deductible in your IRA account.
  • If your IRA account where to sell the property down the road for a big gain, that gain would have zero tax. However, any money withdrawn from the IRA account will be taxed at regular rates using whatever bracket it happens to fall in. Had you kept the property out of your IRA, the gain would have been subject to the capital gains rate which has traditionally been much lower than regular rates.
  • Then there is the big problem. Retirement accounts have a lot of rules. Violate one of those rules and you could disqualify your IRA. This would immediately result in a taxable distribution from the IRA account and be subject to penalties such as the 10% early withdrawal penalty if you happen to be less than 59 and a half years of age. Violating these could be as easy as spending one personal night in the beach house or failing to deposit one of the rent checks.
  • The IRA is going to have to collect rents and pay for repairs. The trustee for the IRA account is probably going to charge you for each of these transactions, usually at rates a lot higher than a normal bank account.

Given the negatives vs. the upside potential, I think this is one of those things that you should put into the category of “just because you can do it, doesn’t mean you should.”

Posted in Tax Planning | 1 Comment

Should you be using the Accrual Accounting Method?

Posted on August 8, 2011 by Jim Payne

The short answer is almost all cases is — “YES”.

The IRS allows small businesses to use the Cash Method of Accounting as long as inventories are not material. This means you can report your income when received and expenses when paid. This approach is much simpler than the accrual method which requires reporting income when earned and related expenses when you become liable for them. The big difference in the results between the two methods is timing. Given a long-enough time period, say 12 months or more, both methods will produce approximately the same numbers. But, can you afford to wait that long to figure out what your true profitability is?

I have seen the scenario of the “cash basis trap” play out numerous times. The sole proprietor is initially very successful using his checkbook balance as his guiding financial metric. If the balance goes up, he is doing well and visa versa. Growth means that the sole proprietor starts to hire employees and equip them. His customers start buying from him on terms and he starts buying from his suppliers on credit. During this spurt of growth, the increasing revenues make that checkbook look pretty good. The owner knows he has building balances in unreported receivables and payables, but for awhile he is able to mentally adjust that checkbook balance to account for them. Sooner or later he loses track of their materiality. However, the checkbook balance is still looking positive so he continues down the tracks not realizing that there is a train rushing at him.

Eventually the sales growth levels off and suddenly the cash flow that was a minor problem turns negative big time. Some of the expected receivables can no longer be expected. The demands from suppliers begin to eat up more and more time.

Digging into the details it finally becomes evident that the business profitability had turned south months ago. Perhaps it was due to cost increases that didn’t get factored into the customer prices, perhaps it was due to some employees siphoning off customer billings. Fixing these problems in the early months, had they been known to exist, would have been a relatively easy thing to do. Now it is monumental deal and maybe not even worth doing. Another small business bites the dust.

Good accounting reports start with using a good accounting method and that is the accrual method. Don’t fake yourself out with cash basis financial statements or your checkbook balance.

Posted in Management | 2 Comments

What is the Process for Improving Profits?

Posted on July 15, 2011 by Jim Payne

Step 1 – You must truly believe that increasing productivity is the only road to producing more profits over the long term.  This is the core function of management, converting inputs to outputs in order to achieve a strategic goal.  You can of course develop a better strategy, but the benefits will only be temporary until competitors begin to emulate that strategy.  It always comes back to being more productive than your competitors.

Step 2 – Start weekly Productivity Meetings that include everybody in the organization.  Sounds incredibly expensive and non-productive don’t it?  Consultant’s have used a standard format for decades — find out what is bugging management, talk to the employees about solutions, and write a report outlining the results.  They understand that it is the people that do the stuff every day who have most of the solutions, if you can just coax it out of them.  Additionally, implementation is a lot easier with people who own the problem and they begin to own it when it was their idea to start with.

Step 3 – When profits improve, reward the people.  This is the core motivator that has made the Capitalist system work for over 300 years.

What would these Productivity Meetings look like?  Initially, it is all about training people to recognize the impact that improving productivity can have on the company’s profits and how they can benefit.  This is best done through analogies, showing how small repeating errors in a process like ordering products will accumulate into sizable amounts over a year. Most people don’t recognize that fixing an error usually costs two to three times more than it would have cost to get it right in the first place.  These fixes over time are not even recognized as errors, so training has to begin with being aware.

Over time, the meetings can shift to more discussions on the specifics of what can be done to eliminate errors, reduce the number of process steps, and all the other possibilities that are a part of process improvement.  These meetings should include acknowledging things that are going right and the people who contributed to the fixes.

Still think it sounds like a huge waste of time?  There are two business models you can build on. The first is the Centralized approach that depends on a few top people to drive productivity improvements when they can get around to it.  The second is an organization that is continually improving because it is teaching itself on a continual basis on how to make more profits.  The second model sounds like the most fun.

Posted in Business Ideas, Business Processes, Management, Productivity, Profitability Principals | Leave a comment

Some Thoughts on the Economics of Housing

Posted on April 5, 2011 by Jim Payne
Robert Schiller’s book Irrational Exuberance includes a graph showing US housing prices for a standard house from 1890 through 2004 which was a real eye-opener. When inflation was adjusted out of the graph you saw a bump in the price after WWII that went up and stayed up and after that a flat line until 2000. The significance of this can be thought of in several different ways.
  1. Clearly, the idea that we grew up with that houses always appreciated was bogus. The major driver was purely the change in the value of money and not the value of the houses.
  2. If there is no real appreciation in owning a home, then the idea that you can justify a bigger house than necessary because of the investment return flies out the window.
  3. Current housing prices will probably continue to decline until they return to the flat line of housing prices that was normal before 2000.
  4. Taxing long-term assets based upon the difference between their selling price and the cost basis is probably unconstitutional.
When you start to think about what forces move housing prices then suddenly it becomes very clear why the only major factor would be inflation. The housing market is dominated by a lot of small builders that are highly competitive. Any jump in demand at some point on the map will increase the price for used houses as well as new houses, but only temporarily. The builders are going to immediately jump in and adjust the inventory so that the prices will again drop back to whatever is normal for the area. The only other factor that could drive prices up and have them stay up is government regulation that makes it more expensive to build new homes.
The bottom line to someone buying a house is to forget this idea that you are investing. Instead, look at it as a decision you making that is purely from a lifestyle standpoint. Set your lifestyle to high and you will have less money to invest for your future lifestyle.
Okay, you got all that, but what about this claim of unconstitutional taxes? The 16th Amendment allows the Congress to levy an “income” tax. If you sell a long-term capital asset, such as a building that you have held for 10 years, and the only increase in the price was due to inflation, did you actually receive “income”? You are certainly not going to find any economists that think so. It seems to me that you would have a real argument that you did not actually receive any real income.
Now, I am not suggesting that you take the Wesley Snipes approach to tax planning by becoming a “Tax Protestor” and not reporting sales of long-term assets. Life can be a lot more satisfying if you simply grumble about the injustice and stay out of jail. But, if you really want to shake up the tax system, then here is what you do. Report the sale of a long-term asset on your tax return. Calculate the price adjusted for inflation and file a claim for a refund of any taxes paid based upon the real income. Once the claim is refused by the IRS, and it undoubtedly will be, head for court. At that point in time there will be a lot of interested parties watching your case work its way through the court system up to the Supreme Court. The return to you for this humanitarian effort will be that tax professionals will forever after be using your name in their nomenclature.
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The Perfect Job vs. the Money Machine

Posted on February 5, 2011 by Jim Payne

Milton Friedman asserted that “there is one and only one social responsibility of business–to use it resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”  Friedman was not discussing this in the context of small business, but large corporations with professional managers and non-participating shareholders.  However, many people have taken the idea that profits should be the only goal of corporations to apply to all businesses.  This is an interesting philosophy question that flies in the face of my experience with small businesses.

The vast majority of small business owners have the primary goal of creating the “perfect job” for themselves.  They want to do the work without somebody else setting quotas and telling them how to do it.  Money is important, but they willing give up large chunks of it to make life easy on themselves.  Failure to make an adequate amount of money will drive them to make changes, but the majority of decisions are aimed at making their work more enjoyable.  I see this all the time in my clients and in my own business.  The decision to put their business close to home and relatives rather than where in the country our product would be in the most demand. The fact that we try to set our prices at a level that will produce the least amount of fights rather than the most amount of profit.  The fact that we tend to hire only a few people that are more like personal assistants meant to do the things we don’t like to do rather than the more expensive people with decision making capabilities.

What about those small business owners in which profits and more importantly cash flow are truly their one and only goal.  These folks are the true engines of job creation.  People are fond of stating that small businesses create the majority of new jobs.   However, it is this relatively small percentage of business owners that actually do that.  Their goal is to create a money machine that does not require their participation in daily operations.  Growth is a major component of most money machines and continual hiring is a necessity for them.

The money machine goal has a considerable amount of appeal to all of us.  The idea that we could be on a three month tour of Europe and open up our computer to find that our bank balances are increasing and that the business is humming away at producing more customers and more cash is quite a dream.  A money machine business is worth millions while the perfect job machine is usually worth considerably less than a couple of hundred grand.  However, the money machine has its draw backs.  It’s riskier for one.  After all, great returns are the result of great risk.  The money machine builder must also be willing to set out of their comfort zone on a regular basis.  The perfect job goal does give you a considerable amount of job satisfaction since you are doing what you like to do and doing it your way.

Why is it important to consider this question of “what is the primary purpose of my business?”  Building a money machine vs. the perfect job are completely contradictory goals.  You can’t do both simultaneously. The perfect job requires that you build a business around what it is you like to do.  The money machine requires that you build a business in which you are not the primary service provider.  To do so would put a huge limit on the money machines ability to grow.  Understanding what you really want is key to building the right business for you.

Posted in Business Ideas, Management | 1 Comment

Phase Training

Posted on February 4, 2011 by Jim Payne

I got this idea from another CPA, Elise Lacher, at my Toastmasters Club.  Elise specializes in veterinary practices and spoke about the idea of having planned training sessions over a period of time for new hires.  This got me to thinking about W. Edwards Deming and some of his teaching about the perils of on-the-job training.

Small businesses have always suffered from affects of OJT.  Workers training other workers with no formal guidelines are just as likely to teach misconceptions and jury rigging techniques without explaining the necessary why.  They do this typically during normal operations with interruptions from telephones and customers.  The result is high error rates and low productivity.  The error rates are particularly costly in the form of lost customers.

Elise’s approach is to have a series of prepared training sessions with outlines.  These sessions don’t have to be long, maybe as short as 20 or 30 minutes.  The big thing is that they are formal training periods with lesson plans spread out over a number of weeks.  Since the periods are short and done in-house, they are cost effective and a huge improvement over throwing the new hire into a 100% OJT program.   

 What training templates should you develop for such a program?  A few jump to mind:

  • The organization structure.
  • The culture and company values.
  • An overview of each of the company departments along with introductions to members.
  • The theoretical aspects of the job and where it fits on the organization chart.
  • Explain who the major customers are and some of their critical idiosyncrasies.
  • Discuss the major vendors and how critical they are to operations.

Here is a thought for business owners.  Maybe training is so important to the long-term success of your business that it’s the last thing function that you should deligate to a subordinate.  If your goal is to build a money machine that will produce cash flow even if you are off touring Europe for a few months, then how well your employees perform their jobs is a lot more critical than how you perform yours.  A formal training program is much more likely to produce people who know their job and how that job impacts the rest of the company.

Posted in Business Ideas, Productivity | Leave a comment

Ditch the Employee Annual Review

Posted on December 30, 2010 by Jim Payne

Annual Reviews are more than a waste of time; they are an opportunity looking for a fight, sometimes with your most valuable employees.  I know, done properly they can be a “great learning experience for all the participants.”  I am sure that something positive could happen from an annual review and maybe I can win at the roulette wheel in Vegas.  You have to ask yourself, what is the most likely outcome from this bureaucratic over-the-top management process?  A happier, more productive employee, or one who walks away feeling unappreciated and picked on by his or her boss.  Why take the risk?

People do need and desire feedback.  It makes absolutely no sense to not provide that information as often as possible so that the employee has a better chance at succeeding at their job.  If you are providing feedback on a regular basis, what’s the point of a formal sit down to say the same stuff again?

Annual reviews have a tendency to becoming a ranking system in which the employee is determined to be average, above average, or below average when compared to his or her fellow employees.  This is the ultimate in stupidity. It might motivate a few of the top performers, but it simply sucks away the pride of the rest of the workforce.  It is easy to forget that every group by definition has an average, but that measure is pointless to use when evaluating the individual members.  After all, even the NASA Astronauts Corp has average, above average, and below average astronauts, but I doubt you would consider any of them to be a poor investment.      

Annual reviews from the employee’s standpoint are more about a pay adjustment.  They may or may not agree with their boss on their need for self-improvement, but they certainly do expect more money if their last pay increase was a year ago.  An annual review is a handy mark on the calendar to avoid forgetting about this important date.  Let me offer an alternative approach that avoids the bureaucratic review hassle.  Provide real increases throughout the year when an employee has demonstrated an improvement in their productivity.  If they are making more money for the company, reward that behavior right away and get a real bang for your buck.  Immediate rewards are a huge motivator.  If they are not improving their productivity, then have a company policy that provides for an automatic increase equal to the inflation rate. 

Annual reviews should go the way of the dodo bird.  Giving people feedback throughout the year, providing more training when it is obvious they are having a problem, and rewarding productivity improvements immediately would be a far more effective policy.

Posted in Business Ideas, Business Processes, Management, Uncategorized | Leave a comment

Book Review: The Logic of Failure: Recognizing and Avoiding Error In Complex Situations by Dietrich Dorner

Posted on December 23, 2010 by Jim Payne

 

We learn from our mistakes.  Or, do we?  This book is about decision making with complex systems.  The author is an expert in cognitive psycho-anthropology (what ever that is) and the bulk of the book is about psychological experiments on how humans make decisions using various computer simulations of complex systems.   His major point is that we don’t normally learn from our mistakes when it comes to complexity because of our various built in tendencies such as seeing cause and effect when they don’t exist.  This is a book worth reading for anybody involved with planning. 

Here are my major take-a-ways from this book.

  • We tend to start making lists of action steps before we define the goals.  In fact, it’s rather easy for humans to develop the goals to fit the action steps that they want to take in spite of the irrationality of such an approach.
  • We tend to come up with one approach to achieving even important goals.  I can certainly identify with this failure, thinking about the number of times I have worked on sales goals that were absolutely critical, but we only came up with one program to achieving it.  Having two or three simultaneous paths to achieving the goals would have been  a lot safer.
  • Our very human habit of first considering irrelevant sunk costs when deciding what to do about the future.  Even when you rationally say to yourself that the past time and cost invested in a project doesn’t count, it still counts.
  • Most of our goals have other goals that contradict each other and that compromises must be made.  There is no “free lunch” as Milton Friedman once said.
  • When it comes to complex systems, in the future I am resolved to:
    • Spend more time in the beginning to try and understand more about the various relationships between the different sub-systems.
    • To develop more specific goals before I start developing action steps.
    • Try to push as many decisions as possible downstream when my understanding of the situation will be better.
    • Produce at least three paths to achieving the really important goals.
    • Favor incremental small changes to avoid overshooting my goals in one area which will probably have some detrimental effect on other goals that are contradictory
    • To put more thought into whether cause and effect relationships are really in existence.    
    • To avoid acting simply for the good feeling that comes with taking action. 
    • To give more thought to the possible side effects of achieving specific goals.

The author also had an interesting observation that applied directly to me, the tendency for a secondary goal to dislodge a primary goal.  The mechanical aspect of computer programming has a great deal of appeal to me and is something that I particularly enjoy doing.  But, when I started my business, learning to program was a secondary goal that was necessary to support my primary goal of improving businesses through better business processes.  I didn’t realize that programming had become such a big part of what I do until I read about an observation of what frequently happens to scientists.  They start writing software to support their experiments and then years later discovered that they had become an expert in computers with some scientific experience in their background.    I think I need to ponder this a little more.

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