Accounting that kills

Last year, I wrote in this space about a common affliction among fast-growing companies when they hit a certain revenue mark. I call it “$3 millionitis,” and it occurs when the systems and procedures that served you well from startup no longer keep pace. It happened at my firm, Inbox Marketer Inc., which this year makes its third consecutive appearance on the PROFIT 200 ranking of Canada’s Fastest-Growing Companies. And as anyone who has been through a case of $3 millionitis knows, these systems never fail you one at a time; everything breaks at once.

The revenue threshold for $3 millionitis, in fact, varies depending on factors such as your industry, corporate culture and how blessedly lucky you may be. For example, your symptoms might occur at the $1-million mark or the $5-million mark. Inbox Marketer fell ill at $3 million—hence the term.

As I reported last year, we cured our bout of $3 millionitis by re-engineering some operating systems and procedures. But no sooner had we recovered when we immediately contracted “$6 millionitis,” the result of the strongest sales year in our history. The big difference with this particular strain of rapid-growth disease is that it attacks one corporate function more than others: accounting and financial processes.
It looks like our cure will be a long one. We’re through the diagnosis phase and have settled on a treatment plan. Just now are we seeing results from our early efforts.

Your company may need a financial makeover if... When I think of what we endured, it brings to mind some of those redneck jokes made popular by humorist Jeff Foxworthy a decade or so ago. To wit: You may be a redneck if your family tree doesn’t fork or fifth grade was the best six years of your life.

I can think of similar telltale signs when companies need a financial makeover—all from recent personal experience. You may need a financial makeover if: your accounts-receivable report reads 90 days but your customer got its first invoice in yesterday’s mail; you’re out by a hundred grand—oops, there it is in the U.S. account no one thought to look in; your bookkeeping staff think “trial balance” refers to the scales of justice; you encounter a nice man from the Canada Revenue Agency sipping coffee in your conference room.

There’s good reason why finance is usually the last area to get fixed in a growing firm: it is the least understood. How many of us entrepreneurs have financial backgrounds? Company founders tend to start businesses in their area of expertise and, unless your startup is an accounting firm, that pretty much rules out finance. Was it any coincidence that Frank Stronach was a tool-and-die maker, or Bill Gates a software programmer? Inbox Marketer—a company that sells digital marketing and publishing services—fits the same pattern. My background is publishing (I’m a former editor of this very magazine) and my VP and co-founder, Geoff Linton, is from direct marketing. Nowhere on our resumés will you find the word “finance.”

No home remedies: As a result, $6 millionitis is one problem you’re unlikely to fix without serious outside help. I was fortunate in finding the exact professional we needed, who happened to be a sailing friend with plenty of previous experience as VP of finance for manufacturing companies much larger and more complicated than Inbox. Dave made a lifestyle change several years ago to leave the corporate world and teach accounting at the college level. Fortunately, he could also make time to consult with us.

Dave started with a careful audit of all our financial systems and procedures, interviewing widely throughout the company as well as our accounting firm. He gained a thorough grasp of how we tracked time, generated invoices, logged expenses and performed bank reconciliations. Then he wrote his report, which generated a mixture of alarm and relief: alarm, in that our processes were inadequate enough to create all sorts of opportunities for abuse; relief, in that no abuse had occurred.

Here are some of the weaknesses he uncovered in our firm; at some point—if not now—you’re likely to embody the same:

All your numbers are up by at least 60%—except one. Sales, profits, transaction volume and accounts receivable all soared in 2010. The number that did not increase was administrative staffing. My fault. When other parts of the business feel the strain due to rapid growth, there is usually someone to complain—like customers. In this case, my loyal, hardworking accounting staff just grinned and bore it.

There’s no internal accounting expertise. Inbox takes pride in being a bootstrap organization in which the sky is the limit for anyone wishing to work hard and develop their expertise, whether it is in IT, sales, marketing or client services. The problem with accounting—and the reason that bootstrapping doesn’t apply here—is that it is a profession. Certification is the ceiling that will not crack for the diligent amateur.

Your auditors are so 30,000 feet. A corollary to the above was that, however excellent the big picture was, strategic advice from our accounting firm could not bridge the gap between the big picture and our rudimentary internal expertise. We needed to build this middle layer ourselves.

You lack internal procedures. Interim adjusting entries to accounts, such as accruals for taxes, prepaids and depreciation, were not made on a regular basis. The big hit here was on our ability to budget. Accrual accounting is essential for interim financial analysis, and ratios cannot be reliable if the base is not consistent.

Accounting does batch processing. The impact this had on invoicing drove the message home for me. We started the process at the end of each month, which meant it wasn’t until the middle of the next month that invoices actually went out. As transaction volume increased, the bottleneck worsened. Dave illustrated how this increased our receivables’ days outstanding and reduced positive cash flow.

Internal control weaknesses make you vulnerable to fraud. Another attention-grabber—our lack of segregation of duties, cross-checks and approvals created all kinds of possibilities for abuse. The fact that one person could open the mail, receive customer cheques, make the bank deposit, post the accounts receivable and do the bank reconciliation without independent review and approval created risk. We needed verifiable checks and balances.

As dynamic as Inbox is from a sales and profitability perspective, we had to get over our own ad hoc approach and manage internal finance with the same discipline with which we manage customer accounts. Dave had us address the problems noted above, but his bigger picture for us was to formalize our entire accounting process.

Getting to the Promised Land is a three-stage journey. The first is the move to true, accrual-based accounting to provide the base line for quarterly comparison. This permits the second stage, which is preparing quarterly budgets and forecasts—the stage we are in now. The Promised Land itself is an operational budget for our next fiscal year and a strategic plan for the next three to five years.

With Q1 results freshly in, Inbox has passed its first test. We’re slightly ahead of plan on revenue, slightly lower on expenses and—most important—amazingly accurate in our forecasting across the board.

The biggest benefit is the new sense of control the management team feels. To forecast, we need to budget; to budget, we need to scrutinize; and to scrutinize, we need to see all the pieces of the puzzle and how they fit. My $6 millionitis feels better already!

Randall Litchfield is president of Inbox Marketer Inc. (No. 117 on this year’s PROFIT 200) and a former editor of PROFIT.