The “Opportunity Cost” of Being Your Own BookkeeperPosted on May 28th, 2017
Outsourced Accounting Department, Inc.
In my recent article, “Why Outsource Your Bookkeeping?”, I explained several reasons why it is advantageous to small business owners to outsource their bookkeeping, such as accuracy and the lack of accounting knowledge, or in general, avoiding making a mess out of your books that someone else eventually has to clean-up at tax time, and at your expense.
I also mentioned in my article another reason to outsource that I think is even more important to you as a small business owner; and that is, the other, more profitable activities you could be doing with your time if you weren’t spending it trying to do your own books. This article from Entrepreneur Magazine, “The 80/20 Rule of Time Management: Stop Wasting Your Time,” hits that nail right on the head with this statement:
“Sometimes you have to do everything when you start out. But now you’re doing a $10 or $20 per hour fix-the-faucet job and you’re not doing your No. 1 job, which is getting and keeping customers. That job pays $100 to $1,000 per hour.”
The author’s example of how this particular business owner is spending his or her time is an example of the old cliché, “penny-wise and pound-foolish,” and his point is a perfect example of an “opportunity cost.” So how may this concept also apply to doing your own bookkeeping?
To illustrate, assume your sales are currently running at $100,000 a year, and your gross margin after your direct cost of sales is 50%. Now assume that by shifting your focus from “bookkeeping” to “marketing” you could increase sales by say 20% per year to start. The increase in your available profit would then be $100,000 times 20% times 50% = $10,000 (which flows right to your bottom line).
Now, assume that you can outsource all or part of your bookkeeping at say $350 per month, or $4,200 per year. Your “opportunity cost” in this example would then be $10,000 minus $4,200, or $5,800 per year! In other words, that’s the profit you are forgoing by doing your books yourself in an effort to “save money.”
Of course, there may be other marketing costs you would incur depending on how you go about increasing your sales, but you get the general idea. The ultimate question is, as a small business owner, how would you prefer to spend your time, and is that the most profitable use of your time?
Case Study: A Plan To FailPosted on May 20th, 2017
Outsourced Accounting Department, Inc.
In my last article, “Heading off Business Failure,” I referenced an article from Entrepreneur Magazine that listed seven tips to head off business failure. The seventh tip on the list was to “Watch your time as closely as you do your money.”
Related to the above tip, here is another article, also from Entrepreneur Magazine, that I and probably most other small business owners can relate to in one way or another: “The 80/20 Rule of Time Management: Stop Wasting Your Time.” In this article, the author points out various ways we as small business owners can waste our time doing menial tasks that could easily be outsourced to someone at a much lower wage. And by doing so, it frees up the business owner’s time to focus on more profitable business activities.
Another financial term I would use to describe what the author is talking about is “opportunity cost.” This concept basically asks the question, “By focusing my time and effort on these tasks, what is the cost in terms of lost revenues I could otherwise be producing? For example, in terms of the services our firm provides, what else could my client be doing in their own business that could bring in more than enough revenues to justify outsourcing their bookkeeping? (“Why Outsource Your Bookkeeping?”).
But here is a major example of an opportunity cost that I experienced with a former employer. The owner of the business was an engineering-type with a unique niche in a high-tech product, with several end-user applications in both the military and private sectors. The company had built up a strong sales backlog of lucrative contracts with several customers and had a promising future.
Along the way, the owner decided to take on a major contract with a defense contractor that amounted to a research and development (R&D) job, which produced very little in billable revenues in its early stages (and that his competitors had rejected). Then in order to demonstrate his expertise to this customer, he rearranged his entire production pipeline, pushing out more profitable jobs in the process and creating a cash flow problem for the company, ultimately causing it to become past due with its suppliers.
After several months of this, one day I presented the owner an analysis which indicated that over 80% of the company’s labor costs were producing only 1% of its gross profit. However, in his mind he was paving the way for a lot of future business with this defense contractor, and was staying the course. But the way he was doing it was costing him his reputation with other customers due to late deliveries, and slowly bankrupting his company. The last I heard after I left the company (for obvious reasons), under pressure from his bank, he was forced to sell the business for whatever he could get out of it, and went back to being just an employee of the new company.
The lessons to be learned here? Prioritize both your time and your business decisions on activities that make money, not that just stroke your ego. And another side lesson is, if you want to take on a long-term project to position your company for future growth, make sure you have either the profit or proper external financing to fund it. If you lack expertise in these other areas, then seek out professional advice (and listen to it).
Heading Off Business FailurePosted on May 14th, 2017
Outsourced Accounting Department, Inc.
This article from Entrepreneur Magazine, “7 Crucial Money Tips to Failure-Proof Your New Business” reminded me of several real-life experiences I’ve witnessed with clients and former employers. Briefly, these are the author’s 7 tips:
1. Avoid unmanaged cash flow or sloppy books.
2. Obsess over accounts receivable and accounts payable.
3. Know your COGS and your margins.
4. Diversify your revenue.
5. Don’t overpay your taxes.
6. Don’t overpay for anything else.
7. Watch your time as closely as you do your money.
My previous article, “The Difference Your Method of Accounting Can Make,” is a perfect example of items 1 to 3 on the above list (and a few more not listed here). Not knowing where you are financially due to sloppy bookkeeping, or an inappropriate accounting method, can disguise the underlying causes of profitability and cash flow problems. In the case of the client my article was about, it disguised the fact that accounts receivable were running slow, and that below-market direct labor rates, NOT “operating losses” (based on its tax return), and NOT employee overtime, was the cause of both its cash flow issues and employee turnover.
Regarding item 4 on diversifying your revenues, having a major sales concentration with one or two customers is a cause for CPA firms to footnote this kind of threat in audited financial statements, and for good reason. Over the years, going all the way back to my bank commercial lending days, one of the most common reasons I’ve observed as to how businesses get into financial trouble is a major sales concentration with one customer. If anything happens to that customer, even if their payments on accounts receivable just slow up a bit, it can have a major impact on your company’s cash flow, not to mention what happens to your company if they go out of business completely.
Item number 5 is fairly obvious. It’s a matter of finding a tax accountant or CPA that does Tax Planning for Small Business Owners throughout the year, not just at year-end.
Item 6 I think should also be fairly obvious. But that said, again going back to my banking days and some client situations since, I’ve observed that for some engineering types, having the latest and greatest equipment is almost an addiction. And if that equipment is not supported by sufficient sales volume and production levels at an appropriate margin, it just adds to the company’s sales breakeven point, such that, the slightest dip in sales can create major disruptions in profit and cash flow:
And finally my favorite, item 7, watching how you spend your time. It’s amazing some of the things I’ve seen small business owners focus their attention on. Referring again to my earlier point about engineers, for some small business owners it’s all about the “toys,” while to others, it’s all about watching the pennies when the ship is headed right toward an iceberg. An expression I used to use as a financial consultant to emphasize what’s important is “revenue generating activities.” I’ll have more on item 7 in a future article.
Again, the appropriate method of accounting, and understanding your financial statements, your margins, and your cash requirements, are crucial to a small business’ ability to survive.
Retirement Plan Options for Small BusinessesPosted on May 6th, 2017
Marianne Kern, CPA
Kern & Associates CPA, P.A.
Employer-sponsored retirement plans have become a key component for retirement savings. They are also an increasingly important tool for attracting and retaining the high-quality employees you need to compete in today’s competitive environment. Also, keep in mind throughout this article that if you are self-employed and operate under an LLC or corporation, for example, your business entity is the “employer,” and you are the “employee.”
Besides helping employees save for the future, however, instituting a retirement plan can provide you, as the employer, with benefits that enable you to make the most of your business’s assets. Such benefits include:
- Tax-deferred growth on earnings within the plan
- Current tax savings on individual contributions to the plan
- Immediate tax deductions for employer contributions
- Easy to establish and maintain
- Low-cost benefit with a highly perceived value by your employees
Here’s an overview of four retirement plans options that can help you and your employees save:
SIMPLE: Savings Incentive Match Plan
A SIMPLE IRA plan allows employees to contribute a percentage of their salary each paycheck and to have their employer match their contribution. Under SIMPLE IRA plans, employees can set aside up to $12,500 in 2017 by payroll deduction. If the employee is 50 or older then they may contribute an additional $3,000. Employers can either match employee contributions dollar for dollar – up to 3 percent of an employee’s wage – or make a fixed contribution of 2 percent of pay for all eligible employees instead of a matching contribution.
SIMPLE IRA plans are easy to set up by filling out a short form. Administrative costs are low and much of the paperwork is done by the financial institution that handles the SIMPLE IRA plan accounts. Employers may choose either to permit employees to select the IRA to which their contributions will be sent or to send contributions for all employees to one financial institution. Employees are 100 percent vested in contributions, get to decide how and where the money will be invested, and keep their IRA accounts even when they change jobs.
SEP: Simplified Employee Pension Plan
A SEP plan allows employers to set up a type of individual retirement account–known as a SEP IRA–for themselves and their employees. Employers must contribute a uniform percentage of pay for each employee. Employer contributions are limited to whichever is less: 25 percent of an employee’s annual salary or $54,000 in 2017. SEP plans can be started by most employers, including those that are self-employed.
SEP plans have low start-up and operating costs and can be established using a single quarter-page form. Businesses are not locked into making contributions every year. You can decide how much to put into a SEP each year – offering you some flexibility when business conditions vary.
401(k) plans have become a widely accepted savings vehicle for small businesses and allow employees to contribute a portion of their own incomes toward their retirement. The employee contributions, not to exceed $18,000 in 2017, reduce a participant’s pay before income taxes, so that pre-tax dollars are invested. If the employee is 50 or older then they may contribute another $6,000 in 2017. Employers may offer to match a certain percentage of the employee’s contribution, increasing participation in the plan.
While more complex, 401(k)plans offer higher contribution limits than SIMPLE IRA plans and IRAs, allowing employees to accumulate greater savings.
Employers also may make profit-sharing contributions to plans that are unrelated to any amounts an employee chooses to contribute. Profit-sharing Plans are well suited for businesses with uncertain or fluctuating profits. In addition to the flexibility in deciding the amounts of the contributions, a Profit-Sharing Plan can include options such as service requirements, vesting schedules and plan loans that are not available under SEP plans.
Contributions may range from 0 to 25 percent of eligible employees’ compensation, to a maximum of $54,000 in 2017 per employee. The contribution in any one year cannot exceed 25 percent of the total compensation of the employees participating in the plan. Contributions need not be the same percentage for all employees. Key employees may actually get as much as 25 percent, while others may get as little as 3 percent. A plan may combine these profit-sharing contributions with 401(k) contributions (and matching contributions).
Retirement plan rules are complex, and the tax aspects can also be confusing. There are various restrictions on contributing to more than one type of plan in the year, adjusted gross income in the case of joint tax returns, and if you have other employees besides yourself, requirements to offer your retirement plan to them as well. If you need help finding the right plan for you or your employees, seek professional advice from your financial advisor. If you do not have a financial advisor, seek one out or contact your CPA / accountant for suggestions.
Part-Time vs. Full-Time Bookkeeper, Controller, and CFO?Posted on May 1st, 2017
Outsourced Accounting Department, Inc.
In my previous article, “Why Outsource Your Bookkeeping,” I talked about the advantages of outsourcing this unpleasant task. In this article I will discuss the differences between accounting department roles, and when it’s time to bring them in house.
To start, this article from the October 2016 issue of Entrepreneur Magazine provides a good overview of accounting roles: “How and When to Grow Your Company’s Accounting Function.” One role the article leaves out is that of the Controller, which falls between bookkeeper and Chief Financial Officer. The difference between the two is that the Controller’s position is more of an accounting role, while the Chief Financial Officer (CFO) role is more “big picture.” In reality, sometimes they are combined into one position, which I believe is what the author of this article was assuming.
In our business, the organization chart would look something like this with the client in the traditional role of “Chief Executive Officer,” and the boxes in red are the services we typically provide:
As indicated above, bookkeeping is essentially a data-entry function. Some bookkeepers understand basic accounting, others do not. I’ve found that there are numerous bookkeepers out there who “know”QuickBooks, but they don’t understand the accounting effect of what they are entering. In our business, the data entry may be performed to a degree by the small business owner using QuickBooks, and to a larger extent by a part-time bookkeeper on our staff, or in some cases it’s performed entirely by our staff person when the owner doesn’t want to have anything to do with bookkeeping.
The next level up then is that of the Controller. This is more of a traditional accounting role which places more emphasis on financial reporting. The Controller reviews, adjusts, and closes the books after everything has been entered and reconciled by the bookkeeper, and then issues the financial statements to the client. This level of service is where our firm differs from those individuals or firms that provide only “bookkeeping” (QuickBooks data entry).
Finally, the CFO role is more of a financial planning and analysis role (FP&A in the above chart), meaning the interpretation and forecasting of financial statements. (One of my favorite “tongue-in-cheek” definitions of the difference between an accountant and a finance person is that “accountants put the numbers together in black and white, and finance people add color.”)
Obviously, in the start-up stage a business’ accounting needs are very basic and the immediate need is to have an outside CPA firm to oversee and prepare their taxes. But as I have said in numerous articles, tax returns are not appropriate for managing your business, so your books internally need to be maintained differently, and that is not typically what tax accountants do. Rather, accrual accounting is more appropriate for managing your books internally and making business decisions. Over time, managing your books this way will also develop a consistent financial history (profitability trend, etc.) that you may need someday for prospective lenders, etc.
While the business is small, the internal accounting can be accomplished on a part-time, “as-needed” monthly basis, with each accounting level remaining more affordable during the early growth stages. As your business grows larger, the accounting functions become more full-time in terms of weekly hours, and that is when it’s time to consider bringing the positions in-house on your payroll. While there are no hard and fast rules as to when it’s time to add a full-time accounting staff, I tend to use these rules of thumb:
|Gross Revenues||Accounting Staff||Annual Compensation|
|Start-Up to $100,000||Outside Tax Accountant||$500 to $2,000 (Tax Returns only)|
|$100,000 to $5 million||Part-time bookkeeper / controller||$1,200 to $12,000|
|$5 to $10 million||Full-time bookkeeper & controller||$35,000 + $75,000|
|Over $10 million||Add full-time CFO||$100,000 +|
Obviously, every company’s accounting needs are different, so there will be some overlap between business sizes as to when you actually start adding a full-time staff, and who. Also, a major controlling factor as to when to hire a full-time staff person is the company’s bottom line profit. A company with higher profit margins can afford to add staff people sooner than a company with thin margins. Aside from that issue, as I’ve said previously, most small business owners know when the time is right to add a full-time accounting department staff. But until that time, it is essential that proper accounting not be ignored, as that is a recipe for financial disaster.