The CFO Reality Check Every Entrepreneur Needs: Leading Through the Numbers

0:05Hey, everybody. We are here with another episode of Business Lunch with your host, my counterpart, Ryan Dice. Hey, Ryan, how you doing? Good, buddy. How you doing? Good. And myself, Roland Frazier. We are going to talk about one of the most fascinating, cutting edge, insightful, exciting, exhilarating topics that either Ryan or I could think of to talk about accounting today. Accounting. Welcome to - You got to set this up a little better than that because we're going to lose literally all the listeners. Why do you want to talk about accounting and finance? Because you're like, for the record, for everybody listening, Roland told me, he's like, yeah, I know exactly what I want to talk about on that podcast today.

0:43I was like, oh, cool. You seem so excited. And right before we go live, you're like, yeah, it's accounting and finance. I'm like, what the hell? I don't even want to be here right now. So why do you want to talk about this? What's going on and why does it matter? Because I think that how you work with your CFO can be a positive or negative experience for the entire culture of the company. And having recently had a 10 years of reporting that I just couldn't stand anymore, come to a head on one of our companies that we have and another company where the accountant, we went through some interesting challenges as we were talking about converting to GAAP, generally accepted accounting principles to be in GAAP compliance so that we could be a better exit candidate when we want to sell the company.

1:35And we moved accounting, we changed accounting methods from cash to accrual, and it had impact. And I just wanted to talk about it because it's very easy to let the tail wag the dog when it comes to accounting. And I want you guys to know that you need to be vigilant about that not happening. And so I'll tell the story that Ryan and I have experienced for way too long, way, way too long, that finally just got the better of me. And, you know, come on, let's change this. It's completely unhelpful. So our accounting did not have in these companies really a budget. I mean, not a thought out budget.

2:22It had like ideas of what we thought things were going to be, but not a good formal budgeting process. And the report that we received daily for 10 years plus was always pretty much in the red because it assumed that all of the expenses that were coming were going to come, which is helpful to know what are the expenses that are going to come, but it's not helpful to continually feel like you're losing. And the reason that it continually felt like we were losing is because it didn't include any projections for any income. So it was basically, if we look forward as much as 60 days, by the way, and we disregard the savings that we've got, and we only look at the cash flow that we've got right now in our operating accounts, and we pay all of the expenses and have no income but don't get to draw on savings.

3:17Including, by the way, no new income from existing subscriptions, monthly recurring revenue, accounts receivable. None of the historical income. Yeah. Not even income that has already been sold that we would expect to arrive in the period. Definitely no new income that we would expect to generate as a result of just business efforts. None of that was included. It was none of the good and it was all of the bad. And so it was nothing but depressing. And we talked about it and talked about it a few times and talked with our accounting person about it. And it just never did get changed. And I finally hit the breaking point last week because it was like, oh, we're opening up the next 60 days.

3:59And look, you're even more in debt. And I'm just like, but we're not, this does not accurately at all present our financial position. And so let's get off our asses and put the fricking numbers that we expect and the ones we know are going to come in, in there. By the way, this, these particular businesses are heavily income loaded to the back because of how things got sold on recurring. So like the last week is the one where most of the cash comes in. So my first thing is be careful because, and Ryan, I would love for you to speak to how you feel about this too. But I was just mad every time I opened that and I would disregard it and just not open it for two, three weeks, which is not a healthy way to keep track of what's going on with the business because it was unhelpful.

4:56Not only did it not include the income that was expected and historical, but it didn't tell me really with any great specificity what I could do about anything. So it was just basically an exercise in depression every day when I looked at it, which was typically the morning. And so I just stopped looking at it. And then I happened to open it again. You know, it was like two weeks ago. I was like, I got to look at this stupid thing. And it had just, it was with the message of, oh, we're opening up expenses into this now. And I'm like, no, more, no, more. So it's changed now. And it includes forward-looking things and things that we expect to come in so that it's not the completely depressing picture.

5:40Brian, your thoughts? I think the rub is you have, the entrepreneurial mindset is one that is incredibly positive, incredibly optimistic. And so we're always assuming that everything is going to work out, that everything's going to be great, that everything's going to be up and to the right. That is the general assumption of most entrepreneurs. If it weren't, you would never get into business because let's face it, it's kind of a ludicrous activity. I mean, there's a fair bit of risk, you know, a lot of walking very thin ropes without a net. So you've got to be incredibly optimistic to be an entrepreneur.

6:15I think because of that, a lot of non-entrepreneurial types, so a lot of operational types, certainly a lot of finance and accounting types, feel like it is their job to be a foil to the natural entrepreneurial optimism. And they somehow think that what they are doing is good to basically offset the rosy picture with the here's the worst case scenario picture. And I think to a certain extent, they're right. But as with everything else, it's got to be kept into balance. So what we never want is we never want somebody who is in charge of accounting and finance to tell us what we want to hear. You cannot have that.

6:56At the same time, if it's only doom and gloom, if it's only the worst possible version of the story, not only is it incredibly depressing and do entrepreneurs, and I appreciate you acknowledging, like, I just stopped looking at it, right? Because I think that this is the reason that a lot of entrepreneurs don't get into finance and accounting because it's intimidating and because it's ultimately a little bit depressing. And so they'd rather just bury their head in the sand. And that can be really destructive. So number one, it's depressing. But number two, it's also inaccurate. Like what we were looking at was inaccurate.

7:31And in many cases, it was causing us to panic a little bit and say like, oh, we need to pull some rabbits out of a hat and, you know, make some stuff going because we're going to be in the red when, no, we're not. No, we're not. Now, we've been doing this long enough that we sort of had started to adjust, you know, have our own mental adjustments based on, you know, those numbers. But I do believe that the biggest lesson is entrepreneurs, business owners, it is your job to figure out how do we do budgeting? How does our accounting process work? And to partner with your accounting and finance people to produce numbers and results that, number one, you understand, number two, are accurate and allow you to make decisions.

8:12Because if you just live in your bubble and they just live in theirs, you're going to have what we have had. And it's because none of us just wanted to just suck it up and have the conversation about these particular companies. I think we were all just tired. So that's, I guess, my take on it. I think one of the things as an entrepreneur, I know I am guilty of it, and I suspect you are too, is when I come up against an obstacle that certainly, if it's an obstacle that repeats itself or I find someone to be unhelpful, my immediate tendency is to go around it and not through it and to just basically say, that's dead to me.

8:57So this accounting person is dead to me. They're not helpful. I'll get the information I need to run the business a different way. That's also kind of lazy and irresponsible because you should support the team that you've got to get the results that you need or you need a different team is the true thing that the manager wants. But at least in that one, I have the excuse of I'm not really the CEO. So, you know, I can talk about it and say, this is not helpful. And so I stopped looking at it not to bury my head in the sand, which I do think is a risk for people. But I stopped looking at it because it wasn't helpful.

9:38And so I went around it to get the other information that I needed and just basically said, this thing is sitting out there. And I did talk about it, in fairness to me, about five times over the 10-year period saying, this is terrible. And we just never did anything about it. I was saying, in fairness to the leadership team over there, because neither you or I are CEOs of this particular group of companies, they did actually create a budget. They did work out a framework for a new reporting process. It was never implemented. And that CEO also just kind of got frustrated and was like, I'm just going to do my own.

10:12I'm going to be looking at my own numbers. I'm going to be going to the P &L. I'm just going to ignore that report for the same thing. It's like, I've, you know, I've got it. Accounting resources to prepare the report. Exactly. And then ultimately, and I think this is the problem. And this is where it is very, very important as a business owner, as a CEO, that you realize and acknowledge that these people, they work for you. And this is not a power play kind of thing, right? It's not a, oh, I'm more important than you kind of thing. But I do believe those of us who are entrepreneurial leaders who don't necessarily have a background in finance and accounting, we can let the finance and accounting types intimidate us.

10:53And we can let them say, oh, well, you just don't understand. This is how it's supposed to be done. This is how I have to report this. And there's a difference between, yeah, this is how I've got to report it for tax purposes. And this data is not helpful for me. And so to push back and say, this isn't helpful, this isn't realistic, I can't make decisions based on this data. and you accounting finance person need to figure out how to bridge the gap between what is and what I need. That is your job. And if you can't do it, you can't occupy this seat. That's what we need to demand. And I remember this particular person who was on our team on the accounting finance team, when we push back, we're like, I don't want this.

11:31Like, this is not helpful for us. So like, well, I'm going to continue creating this report because, you know, it's helpful. It's helpful for me. and and so like basically the the reason that this was never fixed is because kind of the this individual just sort of if you've ever like had a toddler through a temper tantrum and they just go limp right and you're trying to move them and they're literally like you know this sort of limp body and you can't that's that was basically their defense mechanism you know through this and they just figured out if i go limp if i go oh yeah i'll get to that and they never get to it And if we don't follow up, so that's a problem.

12:07And that's a problem that unfortunately, like we're going to have to, you know, address and, you know, and deal with. But that was basically what happened. And this person felt like it was more important for them to produce reports that mattered to them than it was for them to produce reports that matter to the entire executive leadership team. and that's a failure of realizing the team that you're on is more important than the team that you lead. And this is across the board. This is like a sales failure of leadership to correct the issue. So it's a whole lot of things for you to think about.

12:40Yeah. But I mean, it's equivalent to if a sales manager or a VP of sales, something like that, wants to change up a comp plan because it's going to make it more likable and more popular with their salespeople, even though it's not the right thing for the company. When you are a part of a leadership team, whether you are leading that leadership team, or, you know, let's say you're listening to this and you're, you know, you're a VP and you're, you know, are an executive on a leadership team. That team that you are on is team one. That is the most important team because that team lives to serve the company.

13:09That team is more important than the team that you lead. And it's more important than your particular needs and proclivities. And so making sure that we're first running it through the filter of, is this right for the company? Then we can say, is this right for the, you know, for the team, is this right for me? And if those things become misaligned, well, the company's not going anywhere, but maybe the person needs to. Yeah, exactly. So I think that's like the first thing is, is you've got to be able to get the information that you want and need to manage the business. So that's the thing one.

13:44Thing two is very often you will find resistance to getting you what you need and you need to stay on top of it. And as Ryan said, it's either that person that's occupying the seat to get you that information and data can get it or they can't. And I'd say, you know, you're looking at a three month, maybe runway of support and educate to terminate if they can't do it. It's that critical, particularly with your financial information. It's the life's blood of the business. So that I'd say is one of the things to think about. And the other is, is that be careful to structure the information that you receive in a way that empowers the company.

14:29It is empowering to know if you are in trouble, but if it's all the bad and none of the good, if there's no gamified winning that's taking place, then you really will disincentivize yourself and your team to even look at the information, right if you're looking at a horror show every single time you look at the email or the financials then ultimately you're going to be negatively reinforced to the point where you just don't or you glance at it or you say ah yeah but you know most of that's just doom and gloom and you might well miss something that's really critical that's coming at you in terms of a trend or something like that so that that that's the first thing i wanted to talk about any anything else on that before we hop to part two?

15:16Yeah, I do think just making sure that the information that you get is anytime you're looking at data, asking the question, does this data produce informed decisions? Does it lead to action? Because if you're looking at, if you're receiving data that you never are looking at because you find it's unhelpful, then kill that report. Just get rid of that report. More data is not necessarily a good thing. And if you're getting data that's causing you to take bad actions because you're panicking all the time, then there's a problem with the report. So look at the fruit on the data tree. And if the fruit of the data tree is rotten, then there's a problem with the tree.

15:55It's not a problem with the fruit. Do you remember, this was maybe four or five years ago on that same report, that underneath there were like 40 different graphs and things. and we had a conversation. It was like, and we were all like, there's absolutely nothing helpful in any of those. I don't look at them. And it was all being created manually by the accounting team. I think we ended up like not needing one or two people after we all said, don't send that. Yeah. There were two people whose full-time jobs was producing these charts that literally nobody looked at and we never even asked for.

16:31And I do think that this, that it is important that you, you pause from time to time and you look to purge both your data and reporting and also your meetings. Like once a quarter, you need to take a good look at what are the reports? What's the data that I'm looking at? What are our scorecards? And ask, what on here do we no longer need? What is no longer helpful? Purge it. If you find you miss it, add it back. It's really simple. If you're like, God dang it, it turns out I do miss that. More times than not, you will never miss it. And the times when you do, you'll know where it is and you can go and get it if and when you need it, but you don't need regular reporting on it.

17:07Same thing with your meeting rhythm. So what we're really talking about communication architecture. We're talking about the user interface of a business. And just like most of the products that you know and love, the products that you love the most are the products with the simplest user interface. You know, the original Apple iPhone with just a single button and now no buttons, right? We simplify the user interface of your business and that looks like your scorecards and your beating rhythm. Hey, business owners, I've got a quick question for you. Do you feel like you're missing the data you need to make strong business decisions?

17:41If so, it's probably time to build a CEO dashboard. It's an easy way to get everyone in your company literally on the same page, focusing on the numbers that matter. So the scalable company put together a free spreadsheet template that will give you everything you need to deploy your own dashboard. And to make it even easier, Ryan Dice recorded a short training on how to use it. If you want to get your hands on the template, go to businesslunchpodcast.com slash dashboard. That's businesslunchpodcast.com slash dashboard, and you can download it for free. Yeah. The second place I wanted to kind of go is in a different business.

18:15We have been going through this, let's get ready to exit, let's position the company. A pretty typical thing is to move from cash-based accounting to accrual-based accounting and to very often upgrade the finance team. So in this company, the person that was handling finance was doing it in a very rudimentary way. It was basically a one-person, two-person show. And they came and said, hey, the business has gotten to the point now where I'm out of my depth. I think I need to go and you guys need to find somebody better. It's good because that was something that we knew needed to happen. And it just was able to happen in the best possible way.

19:00We did a search, found a experienced CFO. The CFO came in, CFO hired an FP &A, financial planning and analysis guy, and a, or person, I should say, and a controller who does the accounting stuff. So we had that big three triumvirate of very expensive accounting personnel. And we still have them. And a few things happen. One is the rest of the company, I think initially and still, because it's still relatively new, sometimes has a challenge with, gosh, that's a lot of money that we're paying for that team. And what are we getting for it? Well, what we're getting for it is the ability to sell the company for a lot more than we would be able to sell it if we had the other very, very not adequate reporting for going to the level we were going to, or we're already at really.

19:57And you kind of have to have those people and they cost what they cost to get a good team. And so what you get is if nothing else, you get clean financials and you get to know where you stand and you get to sell. But part of the process in moving from one accounting method to another is that numbers are going to change. And so if you lay out a post accounting method change pro forma looking forward statement, which has all kinds of assumptions that we were just talking about, which is where these things I think come together, against a historical cash basis accounting statement that didn't have all of that stuff in it that was basically looking at how things actually went, they're not apples to apples.

20:48And so what happened was this past week, we had a side-by-side historical last year statement put up against a year-to-date plus pro forma looking forward statement. And it freaked a lot of people out because it was about 70 % lower in profit than it was last year. Now, is the company performing at 70 % less than last year. No, actually revenue is up. Profit margins are down. Um, and we've hired several new people. Um, but it's not, there's not tens of millions of dollars of difference in profit. And so the important thing is like, number one, be sure that you're looking apples to apples when you go through something like this, or even when you're thinking about it and what might have been a smart exercise now that I think about it, that we might, I mean, I guess you end up there anyway, but you might want to have a, if you've got the bandwidth, you might want to have the accounting team apply their assumptions to the year before with the accounting method the year before to show you what the year before would have looked like so that you can see the apple and the orange with a period that you already know.

22:17Because when you're looking at what you know and what you don't know, it's different, right? Now, so here's some of the things that happened. Like when we were going through that, it was, well, we had to change how two of the people who are effectively principals of the company who receive millions of dollars of distributions basically got reallocated to compensation or independent contractor compensation. So that reduced by millions of dollars the net profit of the business in the next year. Also, the revenue recognition rules of GAAP for subscriptions say that income has to be recognized basically as the services are received as opposed to all at once.

23:11So the company before was cash basis is just cash came in for something like a tax return that wouldn't be prepared for years, you know, for maybe a year or two in the future. And there are other examples of things like that, too. Like in a digital marketing agency, maybe you need a lot of information from the client or maybe you've got a, you know, particularly in services, you've got a book that you're helping somebody write and it's going to be a 18 month process. Like there's lots of scenarios where the thing is going to take time to perform. And so you're not really allowed to recognize the revenue at that time.

23:50Well, that's going to, your expenses are recognized when you incur the expense. So if you, and not even when you pay it. So you might even incur an expense and be able to pay it over time, but you've got to recognize it now and you've got to defer your revenue recognition. So you've got immediate expense recognition, which lowers profit. it. And then you don't even get to recognize or offset it against the revenue that you've got coming in because that's got to be recognized a different time, even though you have the cash, even though you have the cash and even though you have the cash and didn't put out the money for the expense, which means a pretty wide gap sometimes.

24:24So we went through the financials and we have a meeting on it this coming week. So it's very, very fresh in my head to talk about this, but my suspicion is, by the way, true to good accountants, not necessarily good financial practice, but they didn't assume any of the growth, or at least my understanding is. So I'm not completely clear on that yet, thus the meeting. But my understanding from the COO is that none of the anticipated growth of things that are in process was accounted for there. And of course, the accounting team can say, yeah, but we don't know if that's going to happen and that's a fair discussion.

25:11But in a pro forma, a pro forma is looking forward. It's not, to me, something that should be ultra conservative or ultra aggressive. It should be what we think is going to happen. And so if you bake that stuff in and you get the accounting method worked out and the changes to compensation and a couple of other things, then it probably is going to be very, very close, if not better or slightly better or slightly worse than last year. And God forbid any of the initiatives that we have. I mean, the business has grown historically year over year, every single year by double digits. So, you know, let's assume that happens again, too.

25:55Then life is looking pretty good. But if not, you're like, oh, my God, stop everything, cut everything off, turn off the water, you know, fire these people. And and that's not healthy. It's not really a good way to be. So I think you want to be careful when you're getting into accounting to be sure that you understand the full story. Because a lot of us, you know, as entrepreneur founders don't speak accounting. And, you know, if you don't, then you don't, you might not be thinking about these things. You might not know them at all, or they, you might have them like in the back of your head from your, you know, early days in the accounting classes you may have taken, but it's not something that's top of mind.

26:36Now, that also applies to how you structure things. So in this business, one of the issues with going to Gap was it was going to be very expensive. We're looking at an exit three to five years from now. So it was like, well, we need to go back three years. So we have three years of audited financials and we're going to have to convert all those to Gap and it's going to cost a lot of money and it's going to be a lot of hassle and everything. And my answer to that was, why do we need to go back three years? So we need to go back three years so that we have three years of audit financials to get them.

27:09I said, well, if we don't start our process for a couple of years, why don't we just start doing the audit now? Why don't we go to GAAP now, not retroactively? And then we'll have three years come the time to exit. And God forbid that somebody comes in tomorrow and says, I need to do it and I need these, then we'll create them. Right. So why go through all that hassle if you don't have to? Similarly with revenue recognition, it was well Because there's a giant there's a there's a large payment that's up front right now And that takes care of sales commissions and initial expenses and things like that And then the thing that they are paying for isn't going to be done Like I said write a book digital marketing agency tax returns all that kind of stuff For some time in the future.

27:57So we have to recognize the revenue in a different way than we're recognizing it right now So, you know,$10 million of your, let's just make that up, right? $10 million of your revenue is gone for a year. It'll catch up next year. And then after that, we'll have it again. But sorry about that 10 million this year. Well, I mean, what if we look at how we contract for those services and we contract for them in a way that allows us to have the revenue recognition now as much as possible, but recognizes the value of the thing that has to actual completion of the thing that has to be done that is considered the right now, the ultimate performance of what we're doing and let's restructure it.