Brenda headed a multi-million dollar consulting firm primarily focused on government projects. Now in her 20th year, she was a thought-leader in her field and considered herself quite successful. Her current P&Ls showed decreasing profit and her cash flow had reduced to a trickle. The bank had reduced her line of credit.
Puzzled, she asked us to help her figure out the problem. An analysis of her financial statements showed two problem areas. First, accounts receivable were coming in slower than in the past and her bank had reduced her line of credit because collateral, the accounts receivable, was too little to support the original line of credit.
The crush of three new contracts landing at once put staff under pressure to complete their initial fact finding and analysis work. As a result, invoicing and accounts receivable follow up were overlooked and computer reports did not show the deviation from standard.
Brenda was surprised when we told her that the second problem was not a downturn in profit. In fact, her profit margin had actually increased. The problem was in her accounting system. When Brenda installed her system, she used the default Chart of Accounts for service businesses as suggested by her accounting software. This resulted in ignoring her major asset — work in progress (WIP). The standard setup used the cash basis method of accounting. This means income was recognized when it was actually received and expenses were recorded when paid. This resulted in Brenda’s booking a great deal of consultant salary expense while receiving no income. The result — the appearance of greatly reduced profit.
We added an account called WIP. All job costs such as wages and travel were placed in this account until the job was billed. At that point the costs were deducted to match the timing of the income. WIP is really a kind of inventory account and is recognized as an asset on the Balance Sheet. Once Brenda’s bank understood she not only had significant profit, but also had substantial assets in the form of WIP inventory to serve as collateral, her problem was over. The credit line was restored.
Both of Brenda’s problems arose because she, like most independent business owners, was not intimately familiar with the use of her accounting system to provide management information. Her accountant had not mentioned the discrepancy because he was thinking of her records from a tax preparation point of view. Her books gave him the information he needed to prepare tax returns. Unfortunately, it did not give Brenda the information she needed to run her business and make sound decisions.
Unfortunately, Brenda’s story is not unique. At businessmoneyinsights.com, we’re dedicated to providing practical business financial education in plain English. We’re a “jargon-free zone” where high-level theory that can’t be implemented is not allowed.
We like theory only if you can apply it and get it to work for the benefit of your business, your clients, customers, and patients.
Ultimately, we help dedicated entrepreneurs who have big dreams to make more money in record time and keep more of what they make, so they can continue to make a positive contribution to the world.