Originally published in November of 2016. Updated in February of 2019.
Recently, I marveled at a management team as I reviewed their company’s financial reports. The company had a five-year growth rate (CAGR) of 28%. That growth rate is remarkable by itself, but it was not the growth rate that made me marvel.
Using the company’s numbers, I followed the standard Herring Group process to understand the story of a business: I downloaded my favorite financial report, the trended income statement, from the accounting system. As I described in this blog post, I converted the trended income statement to show expenses as a percentage of revenue.
The marveling began as I read the story that was told in that report.
Strong growth often causes key expenses as a percentage of revenue to increase. These increases occur because the executives are focused on growth and have not implemented systems and financial reports that allow other people to monitor and control expenses. In other words, the company is outgrowing its systems and financial reports.
With this company, key expenses expressed as a percentage of revenue were remarkably flat. Those percentages told a story of great systems and great financial reports.
With that business story in mind, here’s the question we are focused on:
What does it take to have great financial reports?
Unfortunately, the answer is boring – not where CEOs usually like to work. Moving past the boredom and understanding the answer is what separates great CEOs from average CEOs.
Here’s the answer in three words:
The first word is obvious: Data. You need good data in a good system with a good structure.
The starting point for most companies is their accounting system – the foundation for controlling expenses and ensuring profitability. It is difficult to beat the value proposition of QuickBooks for companies up to $20 million in revenue. It is inexpensive, provides enormous value, and improves every year.
For companies larger than $20 million, I like NetSuite. It’s much more expensive to buy, requiring a significant initial investment and specialized people to use it well.
In many industries, companies need specialized software that makes their workflow efficient and integrates with QuickBooks. Examples of specialized software in the landscape industry include Aspire and BOSS LM. Specialized software in conjunction with QuickBooks can often be a better solution than NetSuite or QuickBooks alone.
A good accounting system needs a good structure for the data. The primary structure of an accounting system is the chart of accounts – a listing of every account used to capture revenue, expenses, assets, liabilities and equity. The accounts must be organized to produce an income statement and a balance sheet that tell a clear story.
If you do not find your income statement and balance sheet helpful in making decisions, then you have missing accounts or your accounts are not summarized well. You need a strategic financial person or an industry expert to provide the structure.
Finally, a good accounting system with a good structure needs good data. There is some “magic” in accounting systems that helps ensure good data. However, the “magic” only occurs if the users are following rigorous processes rigorously.
That brings us to our next word: Discipline.
For most CEOs, the idea of building processes and being disciplined in following them is quite boring. Frankly, if I were an investor in the company, I would be scared if the CEO liked the idea of being personally involved in those activities.
The good news is that there are people who were designed to be great at building processes. There are other people who enjoy (yes, enjoy!) following step-by-step procedures. CEOs need these people to process the data that is summarized in great financial reports. Then, these financial reports tell a story that informs those people making decisions.
Decision. CEOs must make the decision— a commitment— to build a team of people to process data and generate reports. These employees or contractors will be different. They will be unlike the CEO. They will not generate revenue. They will not make products or create services that customers buy. They will be overhead. People will wonder why the company needs those people. Their value will not be obvious because many people believe that great data and great reports either do not exist or occur naturally.
CEOs also must decide to train key managers in how to read the story told by the financial reports. Reports must be a key part of regular management meetings. Report-driven decision-making must become part of the culture.
As I said, it is boring: Data, Discipline, Decision.
But the payoff is sweet. The story of your business could look like the company I mentioned above – high growth and consistent expenses. What would that mean for your business, and for your life?
Is there anything that frustrates you about your financial reports? What secrets do you have to obtain great financial reports and understand your business story?
Feel free to send me an email. Your thoughts are always appreciated.