The average business will spend 1-2% of revenue on accounting and finance. 🤓

That means you're at $5 - $10 million of top line before you get a dedicated accountant. But good accounting really doesn't happen until the department is 2-3 people deep - as one accountant usually ends up wearing too many hats (operations, legal, HR, etc.).

So from 0-$20 million, business owners often find themselves in a no-mans land of good reporting. Which means owners need to have a good baseline of accounting knowledge to weather the most critical time in their business' life.

It can be overwhelming, but it's very possible. Today, we're going to do an overview of how to think about accounting 🧠 - in hopes that it helps provide a useful framework in how to look at and understand your financial statements.

All Roads Lead to Cash

This is the first guiding principle in accounting. It's really just a system to track (1) where cash has come from, and (2) where cash has gone.

Owners should look at their financial statements with this always in mind 🔍 - these reports are here to help me understand the past and future sources and uses of cash.

The most popular financial statement is the easiest example to see this - the income statement.

This report shows the historical sources of cash - revenue / income - and uses of cash - expenses. This can get complicated when we bring in accrual accounting concepts - but let's keep it focused on a simple cash only business (like a consulting business). 📆

The second most popular financial statement flows partly from the income statement - the balance sheet.

This report shows what assets - cash or future cash sources - and liabilities - future cash uses / outflows. When you look at your balance sheet, it should always be with an eye towards what can I do to convert my assets in cash faster. 📷

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Where the Bodies are Buried

Good managers understand the income statement - how to boost sales, increase margin, and lower overhead. But it takes an owner mentality to manage the balance sheet - they know that profitable (and growing) companies can (and do) run out of cash quickly. 🤷‍♂️

It's tempting to look at the liability section as the enemy - these are payables, and loans that represent future uses of cash that will drain the business.

But the real alpha is in analyzing the non-cash assets. That's because these also represent uses of cash that aren't helping you (directly) pay the liabilities you owe. Great owners look at their asset section and work down assets that are close to cash (current assets) - like accounts receivable (customer's owe you money) and inventory.

Speeding up the pace at which these current assets convert to cash can save you millions in financing costs over a lifetime of a business. 🔄

The Holy Grail - Negative Cash Conversion Cycle

If compound interest is the ninth wonder of the world, the negative cash conversion cycle is the tenth. 🏆

Cash Conversion Cycle is basically how many days it takes to convert assets into cash. This looks different across industries - but the goal is the same: have customers pay you first so you get free financing.

Customer deposits are "liabilities" for accounting, but they represent interest-free sources of capital for a growing business.

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So when an owner reviews their financials, what kinds of questions should they be asking? Here are a few starters:

1. Balance Sheet:
   1. Is Accounts Receivable (AR) growing or shrinking compared to Revenue? Why?
   2. How old is AR getting and what can I do to speed up those collections?
   3. How can we incentivize customers to pay up front?
   4. Is the inventory number right? Is it turning over (being fully used regularly) or is it getting old?
   5. When will I need to spend more on CAPEX? What's the repair outlay of cash and when do I need that by?
   6. When do I owe these Accounts Payable (AP) by? Am I taking advantage of discounts if I have the cash available?
   7. Are my debt terms optimized? Am I getting the most on a borrowing base I can - especially for a growing business?
2. Income Statement:
   1. How does this compare to my budget / projection? Why is it different?
   2. How are my variable and fixed costs performing compared to projections?
   3. How is margin compared to historical? Where can efficiencies be had?

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The unlock happens when owners look at their income statement and balance sheet and understand both intimately. You can't outsource this understanding if you want to run a good business - especially in the early years.

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🔥 Latest News in Tax and Accounting 🔥

Treasury Revenue Drop Incoming? - A story run by the Washington Post this week cited an anonymous source that the IRS is expecting a 10% drop in tax collections this year due to people "waiting and seeing" about tax reform / IRS abolishment. While we still have 2+ weeks until 4/15 to see what extension and Q1 payments look like, tax receipts YTD by Treasury are actually up 8-10%. So this could be FUD. Source - Treasury Daily Statements from Mar 26 backing out Oct - Dec receipts:

Tariffs Again - President Trump announced new tariffs on automakers, sending many public stocks of the major players downward. Additionally, April 2 is promised as Liberation Day where more tariffs will be rolled out. Interestingly, not a lot of increase in collections on tariffs YTD for all the drama.

Tax Reform Update (or Lack Thereof) - Rumor was that the massive tax reform bill has been drafted and is being worked on. But nothing has surfaced about what's actually going to make the cut. We were initially promised a vote by Easter but that's looking more and more unlikely as Congressional recesses begin.

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