How financial blind spots are killing you

Accountants and CPAs are often ranked as a business owner’s most trusted advisor — over their attorney, banker, and yes, even spouse. Yet there is a common misconception among business owners about their accountant and what he or she “does” for them. This misconception comes about in a number of different ways, between words unspoken, engagement letters unread, and a whole slew of assumptions made by both the accountant and client. It’s about our blind spots.

Take, for example, John. John owns a nice sized business that has he grown over the years. John has an outside accountant, Joe, maintain his books and prepare his business tax return. Every year, through good planning, execution, and understanding of the tax rules, John’s company legitimately reports minimal taxable net income, which then is the basis for the corporate tax filing.

From a tax perspective, Joe is a good accountant. From a business success perspective, however, it is too soon to tell. Even John will say, “Joe is a great accountant, but he doesn’t get my business,” which seems like two conflicting statements. Yet it makes sense because Joe was hired to do the books and the taxes, not be the financial manager of the company. Because of that narrow tax-driven focus, John is only getting part of the story, financially speaking.

Without going all “bean weenie” on you, when financial statements are generated based on what is known as the “cash” or “tax basis,” a company is likely managing its financial heath from a very limited perspective. It’s a simpler approach and keeps the accounting fees down while mitigating taxes. On the other hand, if the accounting is maintained on the “accrual basis” — and then adjusted to the cash basis at tax time — the company has stronger information to work with to effectively manage and grow.

To understand the difference between the cash and accrual accounting concepts, think about your paycheck at the end of the year. Generally, you do the work before you get paid, so you likely worked the last two weeks in December but your direct deposit didn’t arrive until after the first of January. Under the accrual approach, your work was in December and that’s when the expense was incurred. Under the cash method, that expense is in January, regardless of when the work was done. This applies to revenues as well. When a customer bought your product for a Christmas gift but didn’t pay you until January, the same timing difference happens. Results can vary significantly.

All too often, I see the first scenario, where the financials are kept on the cash basis and year-end tax planning drives net income as low as it can go. Lower taxes are great, right? What can go wrong?

Plenty. Consider:

  • Lower taxes come from lower taxable net income or cash-basis profit. This may mean making purchases before you’re really ready, prepaying expenses, or telling customers to hold off on paying you until next year. This could put a squeeze on your available cash or make you consider taking on debt, all in the name of saving taxes.
  • Realistically, the goal of for-profit businesses is to make a profit. It’s the only way to continue to grow a vibrant, valuable, and transferable company into the future. It’s how the owners get a return on their investment and risk of running the company.
  • Tax-driven, cash-basis accounting reports can cloud your ability to match and align your efforts to your results. This may lead to confusion about what’s working well, how profitable your goods and services are, and where opportunities exist to either cull or grow.
  • Financial dashboards often relate current results to prior year and budgeted measures. Changes in tax strategy can throw off the ability to compare and react to changing business realities.
  • Lastly, decisions made in the spirit of tax strategy may not be the best decisions for business strategy.

If this is all so confusing, why is it so prevalent for companies to have cash-basis accounting? Why don’t the accountants have the company’s back, so to speak? Unsurprisingly, it comes down to money:

  • Simplicity: Cash basis is simpler to understand. For the math-averse owners, thinking about the business results and cash as it flows in and out of the business, similar to a checkbook, is straight-forward.
  • Taxes: To some people, the concept of paying any taxes for any reason is so terrible that it becomes “the goal.” This mentality drives how they set up their accounting without realizing the trap that it can set for effectively managing the company, its cash flow, and results.
  • Cost: When you hire an outside accountant to manage your accounting records, there is a cost. The least-cost approach is to only maintain the cash-basis books that will flow directly into the tax return. This saves on monthly accounting/bookkeeping costs as well as a more streamlined, less costly tax return prep fee.
  • Your self-appointed budget manager: Your accountant understands this cost dynamic. This leads them to act as your self-appointed budget manager. In the interest of saving you fees, they may back off from pushing you to maintain a set of accrual financials that are better able to help you manage your business.
  • You get what you pay for: Outside accounting firms have strict standards that dictate what they can and can’t do depending on the nature of the services you hire them for. They can’t take on the role of management and will be cautious to avoid the appearance of doing so.

So, if you hire them to prepare financial statements and a tax return, that is what they’ll do and only what they’ll do. Most don’t take the logical next step to perform analysis over those results like a skilled internal controller or CFO would do. Number one, they weren’t hired to do that, and No. 2, unless they were hired for it, they may not be willing to throw it in as a value-add to the preparation service.

And this, my friends, is why Joe “doesn’t get” John’s business.

Is this scenario resonating with you? Are you only getting the cash-basis statements? Do you fume in frustration over how your accountant fails to have that deep understanding you would like him or her to have? Here are three steps you can take:

  1. Educate yourself on your financial and accounting systems. What are they providing and what aren’t they providing? What parts do you understand? What parts confuse the heck out of you to the point where your eyes roll back in your head?
  2. If you only have cash-basis financial statements, think long and hard about upgrading your approach to obtain accrual-basis statements. If you have accrual-basis statements, determine how to leverage the treasure trove of insight in them to help drive your growth and profitability.
  3. Talk to someone you trust about what you learned — about yourself, about your reports and systems, and about your advisors. If you’re not sure who to turn to, give a shout and we can brainstorm what and who makes sense for you. This is important. Particularly in the current business environment, you deserve and need to have strong financial and operational information at your fingertips. Strengthen you and your team’s responsibility for your company’s financial well-being.

I’ll close this post with this. Our discussion here today isn’t a slam on anyone. After as many years as I have spent working in various CPA firms, I know so many whip-smart accountants who are amazingly talented, deliver fantastic value to their clients, and are straight up exceptional at what they do. Similarly, I sit in awe of the many business owners in our community as they routinely make tough decisions and drive their company’s success.

This is about our blind spots — and the opportunity to see clearer.

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