Operator Accounting Insights

The whole team is here in Calgary! 😉

Cash-basis accounting tells you when money moved. True-performance (aka accrual-basis) accounting tells you when business actually happened.

Under the cash basis, revenue shows up when the customer pays you. Expenses show up when you pay the bill. This might sound simple, but it can badly distort what’s really going on.

Under the accrual basis, revenue shows up when you’ve earned it. Expenses show up when you’ve incurred them. That gives you a much more honest picture of whether the business is actually making money.

Slides two and three are an example of the difference between the two methods. Slide two uses the cash basis, and slide three uses the true-performance basis. The circumstances for ABC Company Ltd. are the same in both cases.

Under the cash basis, it looks like this company lost money in March and April, but made a big gain in May. This is because they didn’t receive any cash from customers in March and April, but made huge collections in May. In this basis of accounting, the company appears to have earned a combined $60,000 profit for the three months.

What it doesn’t tell you is that the company incurred $30,000 of expenses in May that have yet to be paid. It also doesn’t tell you that the company earned $30,000 of revenue in each of the three months, but just didn’t get paid until May.

Under the true-performance basis, we see the real economic activity of ABC Company. They actually earned a combined $30,000 of profit in the three months, and the profit was a lot smoother across the three months than is suggested in the cash-basis P&L. We are not fooled into thinking the business is more profitable – and on more of a revenue and profit roller-coaster – than it actually is.

Continued in comments ⬇️

I often refer to “accounting infrastructure” and how important it is to have it in place in a growing and complex business. But what do I actually mean by it?

While your main accounting general ledger software is part of it (Quickbooks, for example), accounting infrastructure is also:

• Software platforms that your business uses where accounting data flows from (examples are Shopify, Stripe, or industry-specific enterprise programs)
• Software that pulls from the general ledger for financial planning and analysis purposes
• Control systems (policies and procedures) that ensure accurate, timely, and complete accounting data flow
• Human resources that oversee data flow, ensure policies and procedures are followed, and perform quality control over accounting information that’s to be used by management

Having a proper accounting setup means more than just “We have Quickbooks, so we’re good.” Managing a complex business is tough when times are good, and even more so in uncertain times like these. Making decisions without quality accounting and financial information only makes the job more difficult.

Accounting infrastructure is decision infrastructure. Put the odds in your favour.

I’m going to wager that it isn’t messy books that keep you up at night. It’s one or more of these:

• Making a bad hire
• Running out of cash
• Growing but getting poorer
• Losing control

The problem is that messy books mask these problems, and I’m a firm believer that it is generally better to know than to not know. Knowing where you stand is the first step to ridding yourself of that sinking feeling.

The bridge from hustle to established business isn’t more hustle – it’s systems.

If you’re like me, you may have started your business as a side project. It was exciting in the beginning, but eventually it became time to take the business to the next level.

If the business is just you and maybe a small team, how do you find the time to be your company’s chief salesperson? The answer is implementing systems.

What do I mean by systems?

• Accounting and financial planning infrastructure (how we know how we’re doing and where we’re going)
• Documented policies and procedures (doing the right things and doing things the right way)
• Taking steps to make the business less dependent on your everyday involvement

Your blood, sweat, and tears got your business off the ground. To make it truly fly – and to be the vehicle for your ambitions – it will take a series of systems.

There are many reasons that a business will need to borrow money, including:

• Purchasing equipment or property
• Covering seasonal cash shortfalls
• Acquiring a competitor
• Expanding the business

Seeking credit right before any of these occur can be viewed by banks and other lenders as
high-risk behaviour, as it signals a lack of planning. Banks don’t like lending money at the
moment you need it, so it’s better to have debt instruments in place before you need them.
Otherwise, they may impose higher interest rates and/or restrictive debt covenants on your
business (ex: you cannot let your current ratio fall below 1.2, or something similar).

In particular, I recommend to small businesses that they should take out a line of credit as
soon as they’re able – and while they’re in a relatively stable position. This instrument gives
your business some breathing room should there be a temporary cash shortfall, and
interest is only incurred if the credit line is used. If it’s never used, there’s no interest to pay.

At all times, it is good policy to be in regular communication with your lender and let them
know what’s going on in your business, good or bad. This way, there’s time for you and your
lender to work on a financing solution that works for you.

Lenders – like banks, government agencies, or private sources – have a plethora of options when it comes to which businesses they will lend money to. They are also in the business of making money (or at least making their principal back), so they want to be sure that the people running the business they might lend to are doing their utmost to bring about success.

A mark of a diligent and ultimately successful loan recipient is keeping an eye on the future, not just looking at the past. This means doing things like cash flow forecasting, budgeting, KPI tracking, and long-term planning. Lenders that see you doing these tasks are more confident that your business is well-managed, meaning you are more likely to receive the capital you need to take your business to the next level.

Understandably, managing the day-to-day activities of a small business often doesn’t leave much time for this kind of work, though. That’s why it’s important to have someone on your side who can help with it!

It’s not a long quiz — just five questions about your company’s accounting infrastructure, grading yourself on a scale of one to five. I think you’ll find it enlightening.

You can find the link to my Substack in my profile page!

I’ve spoken recently about cash flow forecasting, which is a vitally important task for small business owners to understand. It can be a challenge even when revenue is relatively predictable, but what do you do when revenue is sporadic and unpredictable?

There are a few tactics you can deploy:
• Use large data sets from the past. If you have a few years worth of data to pull from, that’s your best bet for determining averages.
• Use conservative projections and assume the worst. It’s better to be surprised by having more cash than expected than the opposite.
• Be assertive and regular in collecting receivables. If there’s cash out in the world that belongs to you, getting that into the bank is a great buffer for when revenue is slow.
• Negotiate longer payment terms with vendors, if possible. If you find yourself in a cash surplus, you can always pay vendors earlier than the terms dictate. I would be careful with this, though, because you still want to be seen as a reliable customer who pays on a regular schedule.

On its own, the process of forecasting cash makes you think more deeply about the flow of your company’s operations. Even when revenue is unpredictable, cash flow forecasting is still a valuable exercise.