The Entrepreneur’s Guide to Healthy Financials

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Not all entrepreneurs and business owners are also financial wizards. That’s why it’s vital to make sure you have a person on your team that can pick up that task and do it in a way that shares your business growth vision, understands your needs, speaks to you in a way you understand, and doesn’t just throw around fancy accounting jargon.

But where do you start? Do you hire an accountant, a bookkeeper, a CFO? All of these roles perform essentially the same task, but the way they do it may or may not align with the way that’s right for your particular business. Knowing where you’re at, where you want to be, and what you need to do to get there are all part of what makes a good business finance officer.

 

 

 

Rich: She’s the author of, Your First CFO: The Accounting Cure For Small Business Owners, and the entertaining and informative host of the Cash Flow podcast. She guides entrepreneurs on the path from six figures to seven figures with confidence and restful nights. As an entrepreneur herself, her mission is to bring a financial breath of relief to as many entrepreneurs as possible by removing the painful parts and giving them the comfort of knowing exactly and only what they need to know about their own numbers. Fellow Agents of Change, please welcome Pam Prior.

Pam: Hi, thanks so much for having me, I really appreciate it, Rich.

Rich: Well I’m happy. This is definitely a slightly different take on what we usually talk about but it’s going to be fascinating, I’m looking forward to it. But before we dive into all my questions I just kind of wanted to bring people up to speed. How do you get to this place where you’re an author, a podcaster, and focused on entrepreneurs?

Pam: Thank you for that, good question. I started out my finance career in industry, so like a lot in this world today I started out in Fortune 500 – in fact, Fortune 50 – in the financial field. So I got my training in large industry. In between some of those jobs, as we sold companies or there were changes in ownership, I would take consulting jobs with smaller and smaller business. What I found was I was getting a lot more excited about the work I was doing in the breaks than the work I was doing in industry.

So about 2016 I took my final leap away from industry, voluntarily, and said it’s time for me to work with the smaller businesses. And that’s where I came across this really energetic new world of entrepreneurs that I’m enjoying – where I met you, actually – is in this circle. And everything I learned in corporate applies to these small businesses, but nobody is translating it in a way that it can be useful and that it’s in English and that the owner gets relief out of their financial conversations instead of exasperation.

So I started off with my publisher who read my ideal customer target avatar and said, “Oh my god, I need to hire you.” And through her – this is Angela Lauria – just how important this work was to more and more entrepreneurs. So that lit my fire and it has ever since I left industry and it’s so much fun to see owners transform from being scared of the finances or bored of them, to realizing this is fantastic and really useful stuff, and they now have a good gut feel about what their business is doing.

Rich: Well it’s a relief to me to know I’m not the only entrepreneur with a financial blind spot out there, because this is something I’ve struggled with. I’ve been in business for over 20 years and it’s still something that I feel like everybody gets but me. So I’m glad to know there are a lot of other people in the same boat as me.

Pam: I can promise you that of the entrepreneurs I’ve spoken to over the last 18 months – and they range in startups to 8-figure businesses – 80% of the entrepreneurs have the same feeling you do or some version of it.

Rich: You know, I just never went to business school. I was an English major and I just kind of stumbled upon this because I liked computers, and that ended up getting me onto the web. So even when I’ve taken those two day Pryor courses where you go out and spend a couple days with someone, I walk out and I don’t understand anything. So I’m glad you’re here to help us today.

Pam: I’m glad you put it that way because that’s the way I think of myself, as a translator between accounting Greek and entrepreneur English.

Rich: Exactly. So as a small business owner, or as a marketer even, what are some of the key metrics that we should be paying attention to?

Pam: That varies a little bit, but on the whole there is always a cost for acquiring a client, which is always key. And there’s always cash flow. And that’s the one that quite frankly is regularly overlooked. So one of the things I think is really helpful for folks to understand and know that it’s not just important how much you’re selling, it’s important how much and when you’re collecting the money.

So one of the key metrics is cash flow. And really all that means is each month you look at and predict how much cash is going to be in your bank balance at the end of the month, and you look out a few months based on what you’re expecting in income and what you have in expenses, and you see how you’re trending versus that prediction. So that is a key one.

The other key one, and I’m skipping over the obvious ones right now because I think everybody knows net profit, net income, gross profit, all the different things that they’re called and quite frankly everybody has a different definition for in the entrepreneurial field. Those are some of the basics.

But one of the things that we forget – especially startup entrepreneurs – is that if I’m going to get a certain number of clients, those individual clients are going to get from me a certain amount of value in the lifetime of a client. So let’s just take a really easy example here.

Let’s say I sell one thing and it’s a membership site and it’s $100 a month and I expect most clients to stay with me for two years. So the lifetime value of a client in that example is $100 a month x 24 months. So my lifetime value for that client is going to be $2,400. So what I want to make sure of is that I don’t spend more than $2,400 to get that client. And that’s called “client acquisition cost”. So I want to make sure that I have something in place to know what my total lead generation spend is, and that includes everything from hiring an outsource person to help you do your marketing, to your Facebook ad spend, to your Google ad spend, anything you’re spending to acquire a client, and make sure that on the whole it’s not costing you more than that client is going to pay you in their lifetime.

Rich: And is it what they’re going to pay me or what I’m going to make off of it? So am I paying attention to my gross revenue or my net revenue?

Pam: You’re actually paying attention to your gross revenue. But what happens is because when you look at your gross revenue you back out all of your expenses. And what tends to happen is people back out all of their expenses except this one. So it’s just one of the expenses you need to make sure you back out and you don’t end up at zero in total. That’s a very good point, Every single one of your expenses can be looked at the same way.

Rich: Ok. And this may be backing up a little bit, but I hear a lot of financial roles being thrown around in a small business – bookkeeper, accountant, staff accountant, CFO – sometimes these people may work for us, other times they might be freelance. What are some of the roles and what do I need as a small business owner?

Pam: So the most important ones that I think for most of what I believe your audience is, is you definitely need a tax accountant. And the reason you need a tax accountant is because they not only are going to file your taxes for you and get that headache out of the way, but they’re also going to help you as you move through and succeed in business they’re going to help you figure out how to make the best decisions to minimize your tax rate. So that’s a key one. Their role normally – and it varies – but all tax accountants will file your tax returns. You actually want to find a tax accountant who will also talk to you every quarter and help you take a look at what you think is going to happen in the year so that you can start making all the right decisions around how to spend your money.

And I’ll give you a really easy example here. And I’m not a tax accountant so this isn’t tax advice in any way. But the really easy example is if you’re paying yourself out of your business – which I hope every one of you are – if you’re paying yourself out of your business there are a couple of ways you can do that. One of them may cost you 20% in taxes, and the other might only cost you 5% in taxes. So it’s very important to have a tax accountant who knows your situation and can help you make those decisions and save a lot of money. So that’s the tax accountant.

The other thing is what usually happens is the tax accountant will pick a bookkeeper, and the bookkeeper will do all of the accounting but they’re doing it exactly for the tax accountant. So there’s no attempt at all by the bookkeeper because they don’t really know any better to put that information in a form that makes sense to the owner. And that’s where it’s so important to make sure that you define where your key metrics are and what you need to see every month to really feel comfortable that the decisions you’re making are having the impact you expected. And that’s how your bookkeeper should set the books up. And then the tax accountant can always figure out the taxes from the books.

So what happens is a ton of value that you’re paying for in the bookkeeper is lost because they’re literally just serving the tax accountant. So those are the two key roles. Now as a business gets bigger you’ll start to hear terms like “staff accountant”, or “auditor”, or “controller”, or “CFO”. And really the most broad of those is “accountant” and there are a bazillion different kinds. It essentially means somebody who’s going to help start to tie the business information into something that’s useful for the business owner. Because the bookkeeper’s not going to do that, the tax accountant is usually not going to do that. That’s where you get involved with accountants, controllers, and Chief Financial Officers a little further up the line.

Rich: And this is the part that I always struggle with. When I’ve looked at my P&Ls in the past and I’ve looked at my budgets and everything like that, it feels like Greek to me. So I want somebody to dumb it down for me. But how do I even talk to, whether it’s an accountant or a CFO for hire, how do I even explain to them what I’m actually looking for? What would you recommend?

Pam: So what you’ve put your finger on here is the special sauce. When you’re looking for a CFO you want to first find somebody who listens to you. So I’m going to give you the example of the same client again. When I went to work for her originally she said, “Here’s what I think my business is.” , and I made her talk to me for about two hours about how she thought about her business. I didn’t introduce an accounting term, I didn’t talk about depreciation or Quickbooks, I just said tell me how you think about your business.

What a very good CFO will do is translate that into the language that the bookkeeper needs so that they can create some reporting, and then they’ll translate that back into what the owner needs to see. So what happens there is exactly what you said. You don’t need to know the accounting Greek, you’ve never needed to know the accounting Greek. But I can promise you, Rich, you’ve probably had a pretty good gut feel about your business and when you look at that profit and loss statement you go, “This isn’t what happened”, and it gets shoved in a drawer.

So what you want to do is have that intermediary who can take your vision and translate it so that what you get is then just a dashboard. What this client sees from me once a month now is the thing she uses to evaluate how her business is running. And it’s a lifetime value per client, and it’s a cost per lead, and it’s acquisition cost per client, and it’s a total fixed expense number. But it’s the things she thinks about in the language she thinks about, instead of me trying to force accounting terminology on the business owner. 

Rich: Ok, so I think I understand this. I guess part of it is we just have to explain where we see the company going, and then if we have that intermediary person they can hopefully… or is it that we’re organizing our costs and expenses and revenues? I mean, I know there have been years where we said we do web design so that’s a category, and then we said there’s these other things like logo design, and really that should be separated out. Or we used to say we do email marketing – which we still do – but now we kind of put it under content creation because there’s a lot of copywriting involved so it goes with blogs and some other things. Is that part of the changing story of what a business goes through?

Pam: Yes. And that exactly is what I mean when I say that your finances should serve you, instead of the other way around. When I’m in a room and I hear one of my clients saying, “Hey, we’re thinking about expanding a service”, or “I really want to think of all of this as product now instead of two different types of product”, or “I’m adding a new line”, I immediately go to bat and say here are the couple changes we need to make in the financial model. And boom, the next time they look at the numbers that’s all been reflected.

The other big value that’s added even more so than just getting the structure right so that it aligns with how the owner thinks about it, is for example with one client we were going to hire four people and add x number of clients. As it turns out, we’re going to double the number of people we add and up the revenue, and we built a model so that we can drop those numbers in very quickly and immediately see the impact on all of those key metrics. So that’s the other thing of having a little bit more than a bookkeeper and a tax accountant really does help do. And that’s the moment that hits a lot of people in this world who have built a business and all of a sudden they’re bringing in 7-figures. That’s about that point in time when we should start having those conversations, so that it can be really useful to them.

Rich: This intermediary stage, I don’t know if I should call it “storytelling” or what it is, but the interface between the owner’s vision and the hardcore numbers, is there a way to determine whether or not we should be doing certain things in-house or outsourcing them? Because that’s a question that I get a lot and a question that I face quite a bit, too.

Pam: In this world, quite frankly, to get an in-house CFO of the mind that I’m describing to you is a very expensive proposition.

Rich: And I’m not necessarily talking about CFO, it could be something that in my business it’s like a copywriter or a designer. For other businesses it could be something completely different.

Pam: Oh, got it. Alright, so here’s actually where the tax accountant comes in handy. As you start a business as a general rule – and again, I’m not a tax accountant – but as a general rule it makes sense to just bring people on as contractors and they get a 1099. The disadvantage to that to them is that they have to pay self employment taxes on it. If you hire somebody as an employee, of course they don’t have to pay the self employment taxes. So they pay less but you pay more for the same amount of time.

So the point at which it often makes sense to go from a contracted 1099 service to something in-house has a number of factors – most notably your business and how it fits into your business –  but as an aside or one of the inputs to that decision, it’s determining whether you’ve got enough of a cash flow and a positive situation to be able to take on a little bit more money than it otherwise costs to hire that person. Because once they’re an employee there are some additional costs that come into play, so you want to be in a pretty good spot before you start hiring W-2 employees.

Now backing away from that altogether there are all sorts of laws out there around 1099 and employees that I’m not even going to touch on, but it’s not a bad idea to get a good human resources or legal advice on this. Just get an hour phone call with somebody, say here’s my situation, here’s the business that I’m running, what do you think I out to do here form a legal standpoint. That way you stay out of trouble with people and states that want to come after you for hiring 1099 employees when you should hire W-2. So in truth, in summary, it’s a business decision but there is definitely a financial component to bringing it in-house.

Rich: Ok. So you had mentioned earlier when you talked about some of the key indicators that we should be paying attention to, you really focused on two of them. One of them was cash flow. So explain to me, because I remember reading Rich Dad, Poor Dad and how he created an entire board game called Cash Flow. This was the most important thing and I’ve never really wrapped my head around why cash flow is so critical to a small business. I mean I know you have to have enough money to pay your bills, but it feels like it goes deeper than that and it’s just not clicking with me.

Pam: It does go deeper than that, and once you get to Rich Dad, Poor Dad-type status investments. But in the very beginning for an entrepreneur it really is as simple as you said. And the way I would put that is a sale is not a sale for you until you’ve collected the cash when you’re just in the startup stages or early stages of a business. So it really is that simple in the early stages of a business. You need cash to pay your bills and to pay yourself. So if you have a profit and loss statement that says you’re making money but you’re not collecting the cash, you’ve got a problem because  you can’t pay your bills and you can’t pay yourself.

Now stepping back away from that and getting to what he’s talking about in Rich Dad, Poor Dad, is that cash is the way we exchange value. So if I have $1 I can invest in you, I can invest it in real estate, or I can invest it somewhere else. But in order to invest, I have to have that cash. And the person I’m investing it in has to be able to use that cash. And the bottom line is if our whole economy were on barter, you wouldn’t need it. But it’s not on barter, so this is the thing that lets you exchange value in our economy. And I should say today – because as we know with the whole blockchain event – cash could get a whole different definition here in the next five years or so.

Rich: So is there an amount of cash flow, is there a formula that works for almost any size business that I’m like, ok, all I need to have is x% of my receivables = this cash flow, or I need enough cash flow to run my business for 3 or 6 months even if I didn’t get $1 during that time? Like, are their numbers or levels that we should be shooting for?

Pam: Yes, but they’re not absolute numbers. So this is where a forecast really makes all the difference in the world. Because in a business that needs to buy inventory and sell products, is very different from a business that is selling coaching or a membership site. So there are formulas but they’re specific to the businesses. The overall sort of very broad formula is – and this sounds ridiculously stupid or simple, but it’s real – is you need to predict how much money you’re going to need to spend, and based on that, how much money you need to bring in. And then make sure your model supports it.

Now a really good forecast like if I were looking very specifically at your business, I would have five or six things that were driving that cash in and that cash out and that’s what we’d be dropping into a formula to get the right answer for you.

Rich: Ok. So it does sound like it’s a little bit more specific to the business.

Pam: It is, yeah.

Rich: What are some of the biggest mistakes that entrepreneurs make, in your opinion, when it comes to their business finances? Whether they’re doing it and they shouldn’t be, or whether they aren’t doing it and they really should be.

Pam: Well I think one of the biggest things that new entrepreneurs overlook is how much there is to deduct for tax purposes and they pay tax bills that they don’t need to be paying. So that’s kind of one really big one.

The second one is leaving the receipts in the shoebox for too long. Because once the receipts are in the shoebox for a year and then it comes time to have to file your taxes, that is a 3-4 day nightmare that the owner has to go through and they hate it and all they want to do is get it off their plates forever. So what ends up happening is they hire a bookkeeper without really making sure that the bookkeeper is going to get them all the benefits of those reports like we talked about earlier. And that bookkeeper is set up just to serve the accountant, so all the value of being able to forecast and predict and look at your metrics goes out the window in that scenario when it happens.

So the new entrepreneurs I advise to bite the bullet, get a bookkeeper, start doing it early. It’s all automated now. Bookkeepers are not that expensive for a startup business, let’s go ahead and do it. So those are the two biggies, tax deductions and go ahead and get the bookkeeping started early. It makes everything so much easier in the long run. And cheaper.

Rich: Great. Ok. Well I know that we’ve just skimmed the surface because there’s a lot here we can dig into. I’m sure people who are struggling like I am are going to want to know more, where can we send them?

Pam: Thanks so much. I would love to send them to www.pamprior.com. But right now because there’s so many entrepreneurs who are brand new, I’ve developed a program that I’ve been running called Profit Plan, which takes only the essentials for startup entrepreneurs that are in that $50,000 – $500,000 range and gets the essentials in place and we do it while having a lot of fun. So to get to that you want to go to www.grownupbiz.com.

Rich: Fantastic. Pam, thank you so much for stopping by and sharing your expertise.

Pam: Rich, I really appreciate the opportunity.

 

Show Notes:

Pam Prior helps business owners rule their numbers, so the numbers don’t rule them. In her latest book she helps guide small businesses in hiring the right CFO for their company. And check out her course designed for startup entrepreneurs where she helps put the financial essentials in place to get them started.

Rich Brooks is the President of flyte new media, a web design & digital marketing agency in Portland, Maine. He knows a thing or two about helping businesses grow by reaching their ideal customers, and to prove that, he puts on a yearly conference to inspire small businesses to achieve big success. You can also head on over to Twitter to check him out, and he just added “author” to his resume with his brand new book!