Small business owners often look at accounting as a function that only relates to tax filings and financial reporting. There’s more to it than that. Accounting can be used to track spending, measure profitability, and facilitate more efficient growth and scale. The best practice is to “crunch the numbers” before making any major decisions about your business.
Virtual communication, better technology, and the rise of AI have made business accounting more complicated. We live in a digital age where companies can rapidly fail after one or two bad decisions. Ultimately, the likelihood of a terminal event comes down to the management of financial and material resources. That’s what we’ll talk about today.
Understanding How Your Business Works
Your business has a circulatory system that is like the human bloodstream. Cash flows in and cash flows out. Those numbers are used to calculate profitability. Scalability is determined by looking at costs and efficiencies. Think of the profit margin from a macro perspective. Digging deeper to understand how money is spent is a micro approach.
Here’s an example. Let’s say you own a factory that’s putting out a product that is showing a 25% profit margin. That means your costs for that product are 75%. If you grow by opening a second factory, will those numbers be the same? Of course not. Your costs for the new facility could be higher. Labor and transportation costs may differ also.
Growth and scale are different metrics. The company we used as an example above can grow by opening a new factory, but the margins may change. Scale involves keeping profitability constant or increasing your margins when you expand the company. That doesn’t happen without an understanding of your current costs and better cost control going forward.
Another issue is measuring supply and demand, an exercise that has gotten more complicated in recent years. Inflation and supply chain problems have caused prices to go up. Rising interest rates are starting to affect consumer spending. Research can help you understand the causes of these issues. Accurate accounting shows the impact on your business.
Using Accounting to Streamline Purchasing
Growth can create a fractured matrix of suppliers and vendors. This is one of the areas where accurate accounting can help you streamline the purchasing process. Consolidating the purchasing for multiple locations gives you more leverage in contract negotiations. Knowing what the numbers are before you negotiate tells you if that’s cost-effective.
Let’s apply this to the factory example above. One of the challenges with scale is keeping costs uniform across multiple locations. The facility costs will vary based on location and infrastructure availability. Supplier costs can be a fixed percentage if you’re using the same vendors across the entire organization. That makes it easier to calculate profitability.
One of the steps you’ll want to take when contemplating an expansion is to have your CPA create pro forma financial statements (pictured right courtesy of Quickbooks). You’ll need an income statement, balance sheet, and cash flow statement, all put together using hypothetical data. A uniform cost structure spanning all locations will make that simpler. Too many uncertainties can produce inaccurate results.
What we’ve outlined to this point assumes that your business and the economic conditions you’re operating in remain constant. Unfortunately, as we’ve learned painfully in the past few years, the status quo can change in the blink of an eye. Growth could be arrested. Downsizing becomes imminent. Your accountant can help you get through that.
Growth Through Mergers and Acquisitions
Partnering with another firm or buying a smaller competitor are two growth strategies that can significantly increase your profitability. Don’t try to do the numbers on those deals yourself. Most prospective partners won’t even entertain a merger if you don’t have a CPA review the books. Mergers and acquisitions should be fully vetted before you put your cash on the table.
Playing in the M&A space requires advanced mathematics. Few businesses have the working capital on hand to simply “pay cash” for another company. Most acquisitions are done with business loans or venture funding. Mergers involve the absorption of corporate stock and possibly the elimination of part of the workforce. Costs can quickly spiral out of control.
Your accountant can tell you if it’s worth it. Merging with another company might not be as cost-effective as expanding your existing operations. Buying another firm for their assets doesn’t make sense if their balance sheet shows they’re in the red. There’s also the issue of interest payments if you’re borrowing to make the deal. Now is not a good time to take on new debt.
Increasing Efficiency With AI and Systems Automation
The rise of AI is causing a significant shift in the way we do business. It can make your company more efficient, facilitate growth, and streamline costs to properly scale. Sadly, one of those costs could be workforce reduction, aka laying people off. Cutting down the size of your workforce as you automate more systems and processes is an expensive undertaking.
Do you have a human resource department? Their responsibility in this scenario is to protect your employees and make sure they get maximum compensation if their positions are eliminated by automation. Your CPA’s job is to make sure you can afford to do it. Installing AI into your system isn’t the hard part. Preparing for the financial impact is.
Ironically, the automation of your accounting and bookkeeping systems can help reduce the cost of implementing AI that streamlines your workforce. An example of this is installing QuickBooks and connecting it to your bank. Adding a spend management platform to that will give you real-time insights into your employee and department spending.
The Bottom Line
Growth is one of the primary objectives for startups and small business owners. Scale is the ability to grow without significantly changing the cost structure of your business. Accounting is a key element in both. A good CPA can help you streamline your costs, consolidate suppliers and vendors, tell you when it’s a good time to merge or acquire a new business and evaluate the costs of AI and systems automation. Contact D&M Accounting today to learn more.