All posts by Rob Farrow

About Rob Farrow

accountant, entrepreneur, former chef, occasional artist, angel investor, business advisor, corporate tax specialist

CPAs As Advisors To Business

 

When I first began as an accountant in practice, I made a commitment to focus on tax as opposed to business advisory services. I reasoned that my clients had business experience and I had just left the tax department where I’d worked as an auditor. Over the years I have watched as everyone seems to be getting into the act of providing tax, accounting, structuring and general business advice to small business.

What’s more I’ve seen small business owners make the same mistakes over and over again. The majority of small businesses fail in the first 5 years – or at least the owners take advantage of the next upturn in the economy to opt for a steady paycheque and abandon the dream of being their own boss.

I have seen my fellow CPAs being overlooked for their general business knowledge in favour of a host of self-proclaimed experts. These “business consultants” exchange “free” business advice in order to create traffic, get referral fees or sell software, consulting services, online subscriptions – or simply want to be seen as doing something for small business in the case of governments.

The problem is that good business advice has to be context-specific.

I find it particularly galling to see the former owners of failed businesses hired as “entrepreneurs-in-residence” for government-funded incubators or to see government bureaucrats providing testimonials for small business planning and management webinars.

At the same time there have been some interesting developments in management science that have put the boots to much of what I and most of my colleagues learned in business school in the 1980s and 1990s. I think of Strategyzer  and the business model canvas – of Steve Blank telling people to “get out of the building” – or of Eric Ries and his “minimum viable product.

The Lean Startup - Eric Ries
Cover of Eric Ries’ The Lean Startup

No business plan survives first contact with customers

 

The Pace of Change is Accelerating

During the course of our careers many of us have seen incredible advances in technology that impact how we and our clients work together and communicate. As we’ll discuss later on, in 1985 97% of all payments in Canada were made by cheque. In 2018, 86% of all payments are transacted online.

In April of 2014 I began using GOOGLE FORMS for creating online timesheets to use in my practice. By the end of October 2015 we migrated to another application – Smartsheets – for our internal timesheets. Soon we started using Smartsheets for creating deposit books that featured images of cheques that I was depositing to the bank.

While Smartsheet still serves us well and has a great deal of power and sophistication, I decided to re-visit GOOGLE FORMS in August of 2018, since our subscription fees for Smartsheet were starting to escalate.

The upshot is that within 4 years, the evolution of GOOGLE FORMS had by and large eliminated the reason for our original migration to Smartsheet. While Smartsheet is still a great tool, if your needs are fairly rudimentary, GOOGLE FORMS may be a better – and more or less free – alternative.

Continuing Professional Development Needs to Keep Pace

In 1981, public practitioners in BC voted to begin a program dedicated to lifelong
learning with the introduction of mandatory professional development. This has to be more than just a way to generate fees for our professional association. One of our key goals is to provide relevant professional development that actually has practical value for CPAs in practice.

 

Brief History of Bookkeeping

Bookkeeper - Woodcut

Wikipedia

In 1494 an Italian mathematician by the name of Luca Pacioli published “Summa de arithmetica, geometria, proportioni et proportionalità” (Venice 1494), a textbook for use in the schools of Northern Italy. It was a synthesis of the mathematical knowledge of his time and contained the first printed work on algebra written in the vernacular (i.e. the spoken language of the day). It is also notable for including the first published description of the method of bookkeeping that Venetian merchants used during the Italian Renaissance, known as the double-entry accounting system. The system he published included most of the accounting cycle as we know it today. He described the use of journals and ledgers, and warned that a person should not go to sleep at night until the debits equaled the credits. His ledger had accounts for assets (including receivables and inventories), liabilities, capital, income, and expenses — the account categories that are reported on an organization’s balance sheet and income statement, respectively. He demonstrated year-end closing entries and proposed that a trial balance be used to prove a balanced ledger. He is widely considered the “Father of Accounting”. Also, his treatise touches on a wide range of related topics from accounting ethics to cost accounting.”

It has often struck me that a system described so eloquently more than 500 years ago, could somehow be reproduced in software and used by publishers to create an annuity. However that is precisely what software publishers like Intuit Inc. and The Sage Group, plc have done with their popular accounting software.

The fundamentals of accounting theory are basically unchanged since Pacioli’s day. In spite of this, by simply updating tax tables and changing the format of data files, the publishers force small companies – and their accountants – to upgrade their accounting software every year.

As a public accountant this is particularly irksome since most of us use audit software – called Caseware™ – and only purchase low-end desktop accounting software to accommodate our clients. What’s more, the bookkeeping done by our smaller clients is most often done very poorly. In fact it is often so badly done that I am frequently better off to export the bank account from within the accounting software to a spreadsheet, and use that as the framework for a more accurate set of books.

Thankfully the current crop of online accounting software allows companies to “invite” their accountant to collaborate and access their accounting data online – without purchasing a license.

BPO (“business process outsourcing”) for Startups

For startups outsourcing isn’t really new.

As a public accountant I have embraced the concept of outsourcing. Most businesses of any size in North America outsource at least some of their tax and financial reporting functions to local or international CPA firms.

And many startups outsource their bookkeeping to local, independent bookkeepers or bookkeeping firms.

FINDING QUALIFIED BOOKKEEPERS

The key problem for startups is that finding quality bookkeeping services isn’t that easy. As a CPA I know that most of my colleagues have difficulty finding qualified bookkeepers that they can recommend. Most CPAs jealously guard their recommendations and keep them for valued clients.

From a public accountant’s perspective, good quality bookkeeping is necessary in order to provide profitable professional accounting services. For the most part our clients want us to help them file their taxes and they may need financial statements for their bank or investors. Whether our clients outsource the bookkeeping or do it themselves, they don’t appreciate paying public accountants to fix the bookkeeping.

However, all too often the lion’s share of a company’s year end fees can relate to bookkeeping problems – particularly when it comes to small businesses.

THE PROBLEM WITH BOOKKEEPING CERTIFICATIONS

If you research ‘bookkeeping certification’ on the internet you’ll find organizations that are trying to ‘professionalize’ bookkeeping by forming ‘institutes’ and similar certifying bodies. In addition you’ll find various colleges that offer courses which culminate in graduates receiving certificates. While members of these institutes and graduates of these courses may do a decent job of bookkeeping, our experience teaches us to be skeptical.

Education is one thing, while training and experience is something else. The discipline of working under professional supervision is vitally important. As far as I am aware, Chartered Professional Accountants are the only accounting professionals that combine education, mandatory supervision and ongoing professional development.

Perhaps most problematic is the tendency for some of these ‘professional’ bookkeepers to take on too much – particularly as it relates to filing corporate tax returns.

 

OUTSOURCING OVERSEAS

In the past I have outsourced bookkeeping and accounting functions to firms and individuals with recognized qualifications in India and the Philippines. I suspect that this may be an appropriate strategy for some CPA firms, however I don’t believe that accounting firms that reside overseas can readily handle local tax issues on a part-time basis.

A few months ago I hired a recently graduated CPA from the Philippines on a full-time basis. I would point out that CPAs in the Philippines receive their designation shortly after graduation. So she was really a bit of a blank slate when I hired her.

Together we are investing in developing her understanding of Canadian tax issues, and professional working paper preparation. While it is awkward dealing with time zone differences – she starts work when I am beginning to wind down – after a few short months she is progressing well and becoming a real asset to our firm.

 

Key Events in the Financial Life of a Startup

Challenges Faced When Designing Financial Systems for Startups
  1. startups change and evolve quickly
  2. an overly complex system either won’t get used or won’t be used effectively
  3. lack of skilled staff to operate a system
  4. conflicting priorities
Key Events in the Life of a Startup that Effect Information Needs
  1. begin to develop a minimum viable product or service – tracking SR&ED projects, time / analytics re user (customer) experience
  2. begin to sell products – invoicing, collections and receivables
  3. hire regular (as opposed to founders or ‘specified’) employees – payroll records and remittances / holiday pay
  4. contract bookkeeping service – outsourced, after-the-fact bookkeeping
  5. start to groom themselves for investment – building business model, iterating with actual experience, investor-facing communication / elevator pitch, due diligence-ready
  6. hire a controller (or part-time CFO)

Of course every startup is different. In some cases each of these key events happens right at the start. For others the process is slower – and the order may be different.

Why Accounting Software May Not Work for your Startup

Today’s small business accounting software was modeled after systems first developed in the 1970s and 1980s for fairly expensive mini-computers. The cost of these systems – and the people required to run them – had the effect of rationing their use to larger, small or medium-sized businesses (“SMEs”). A company needed to be a certain size before they could justify their use.

Let’s take a look at what the market place looks like. Most people would be surprised at how small most businesses really are –

In fact those early mini-computer systems were really designed for use by companies in the top 5% or so of businesses by size. The volume of transactions is orders of magnitude greater for a company with 50 employees than one with 5 employees. Doing an automated cheque run for a company with 50 employees makes sense. It’s a complete waste of time for a startup with 2 employees.

First you have to record all the payables in the accounts payable module. You’ll recall that our cash-basis system ignored this as superfluous for a small company. Then you have to set the printer up with specialized cheque stock and run the cheques – all of which seems harder than simply writing out 5 or 10 cheques by hand.

The theory is that this captures all the data around the payment automatically, since the cheque was generated by the computer software. This should be a time-saver, except that these days your bank very kindly does the same thing whether the cheques are manual or computer-generated…and you have to download the transactions anyway to import into your accounting software.

So startups should forget about using accounting software to automatically capture transaction data each time they write a cheque or make a deposit. The bank already does that whether you use accounting software or not…

Accounting software was originally designed for use by larger businesses (think 20 employees) – and these larger businesses usually have full-time accountants. For startups who outsource their bookkeeping to an independent bookkeeper, they will have accounting software that they use for their clients.

If you intend to do the books yourself or have one of your staff members do it, you need to think carefully about whether you have the skills – and how you plan to use the information. If the financials are only being used to accompany tax returns and SR&ED (scientific research and experimental development) claims, you should check out the following 2 articles:

  1. What a Simple Cash-basis Journal Might Look Like
  2. BPO (“business process outsourcing”) for Startups

What Makes Financial Accounting Complex?

There are at least 3 processes involved:

  1. keeping and storing records
  2. recording and compiling transactions
  3. financial reporting

from a startup’s perspective, accounting software is very badly designed – because the focus is on financial reporting instead of the first 2 processes – and startups are more interested in tax compliance than financial reporting.

If you think about it from the perspective of accounting software publishers, it makes sense from a marketing point of view to put the focus on ‘producing financial statements at the press of a button’

It doesn’t matter much that the numbers aren’t reliable and that management doesn’t know how to interpret them. They look exactly like financial statements – and you don’t need to pay an accountant to produce them. After all, you may not really understand your accountant’s statements either.

As a software developer would you really want to build a sales campaign around something that is supposed to keep your books and records organized? Perhaps the campaign would look like:

Makes Keeping Records Fun!

Try saying that with a straight face. Keeping books and records is necessary for any business. However it is hard to think of it as fun!

The good news is that financial reporting is rarely an issue for startups. It only becomes an issue when other people put money in your business and are sophisticated enough to demand – and understand – financial statements. For startups and seed stage companies, only friends and family are likely (stupid enough) to put money in your company.

Of course you will still need to report to the tax authorities.

What a Simple Cash-basis Journal Might Look Like

Example of a simple cash-basis journal

The data here was downloaded directly from the bank. With a little formatting the accountant or bookkeeper can quickly develop a useful spreadsheet that can search and filter transactions, calculate totals and generally serve as a useful record for the company.

With some knowledge of advanced spreadsheet techniques (see TRAINING YOUR ACCOUNTANT), your accountant can quickly build a pivot table to summarize a year’s worth of transactions into a single journal entry.

Synoptic

Know Your Compliance Quotient (“CQ”)

Understanding who you are – and being honest with yourself about your characteristic strengths and weaknesses – is important in life and in business. Over the years I’ve worked with entrepreneurs who were extremely well organized and self-disciplined, and who maintained fastidious records.

I’ve also had clients with very high turnover in the accounting department, abysmal financial records and yet managed to be very successful and profitable.

Along the way I’ve come to believe that certain individuals have a high tolerance and capacity for detail – while others rely more on a kind of ‘gestalt’ overview to keep things in perspective. Those with a higher capacity for detail have what I would call a ‘higher compliance quotient’ – a high “CQ” if you like. These individuals are better suited to running companies that are subject to a lot of scrutiny – for example public companies.

High tech startups in Canada typically receive a great deal of funding from our generous tax incentives for R&D. Maximizing benefits under the scientific research and experimental development program (called “SR&ED” or SHRED) generally requires putting development staff on salary and documenting the development activities.

This is not for the faint of heart – or more accurately it isn’t for those with a low CQ. Payroll must be paid on pay day – you can’t put off employees the way can contractors. You should be aware that the Canada Revenue Agency isn’t particularly tolerant of late payroll remittances.

If you are equipped with a low CQ – recognize it and delegate compliance functions to someone more suited to compliance work. In some cases that may mean dealing with an outsourced payroll service.

At home my wife and I buy everything we can on our credit cards, in order to maximize our travel points. However if we miss the payment date, these credit cards have high interest rates, so they need to be paid on time. Left to me we wouldn’t be able to manage accurately enough, since I’m more focused on my clients’ needs and meeting their deadlines than on my own.

On the other hand my wife is blessed with a very high CQ. Over the years we’ve learned to delegate managing credit card debt to my wife. The downside is that I can’t buy anything without her knowing about it….

The Institute of Certified Records Managers (ICRM)

You’d probably be surprised to learn that there is an international certifying organization of and for professional records and information managers http://www.icrm.org/about/ – clearly they work in the shadows at very large governmental and multinational organizations. Otherwise we’d have bumped into them more often.

For small companies the records management functions are typically outsourced to lawyers, accountants, bookkeepers and payroll services. However they are rarely described as records management services. By default bookkeepers typically end up with the lion’s share of the responsibilities, and many have little or no formal training.