Accounting for the Future

My friends will tell you "I do the accounting." By Mark D Gagne

I'm used to the cringed look I get when I tell people I am a certified public accountant. We all know that a CPA is someone who sees the world through green eye shades, who laboriously pores over volumes and volumes of paper, who pounds away on a calculator adding up numbers while reciting the multitude of acronyms (GAAP, EITF, APB, FASB) that comprise that body of knowledge known as accounting; someone who exerts a whole lot of effort to report what happened yesterday.

Fortunately, perception is not always reality.

Is your business accounting for yesterday or is it accounting for the future? Are you looking backward or forward? Are you proactive or reactive? Better yet, how clear is your vision of the future?

Accounting for the future means?planning the process?and?processing the plan. It means controlling your destiny by enabling informed decision-making throughout your organization.

Planning the process?requires you:

• To establish realistic goals and objectives based on your knowledge of the rules and facts and their interrelationships (recognizing that any significant decision will typically have more than 10 relevant facts, like the facets of a decagon, which will impact making an informed decision).
• To establish strategies for achieving goals and objectives.
• To involve all constituents in developing specific tactics and action plans with ownership and timelines to ensure you have clarity of understanding of the strategy, goals, objectives, timelines and measurement points as part of the plan.

Processing the plan?requires you:

• To understand how you will empower your organization with the right information and tools to manage the process to achieve the desired results: knowing what to plan to account for in operationally significant terms (quantitative and qualitative metrics and benchmarks) to achieve your goals and objectives.

You are accounting for the future when you have accounted for your plan based on an input of all the relevant facts by all constituents in a manner that will enable your people to execute the plan through a managed process that provides mechanisms for effective communication and timely measurement.

Knowledge of accounting is one of the many facts that must be considered when accounting for your plan as it provides you with the rules on how your operating results will be tabulated. Too often accounting rules are overlooked in the planning process and although operating results were achieved, the accounting (reporting) of the results provided a different score.

Running a business means taking the time to know and leverage all the rules to your best advantage during the planning process. When planning the process you must incorporate a thorough understanding of not only the accounting rules but also understand the other rules, boundaries and facts that will impact the processing of the plan.

It is important to know the rules, use the rules and win the game.

When Tiger Woods asked the gallery to move a large rock that was in front of his ball so he could hit a shot, I stood and applauded. Because Tiger understood the rule of golf regarding loose impediments and embedded objects he was able to use it to his best advantage enabling him to have a clear shot to the green. Probably saving Tiger at least 1 stroke, which in golf can mean the difference between first and second place; that's often hundreds of thousands of dollars.

Effective decision-making and problem solving within your organization requires an understanding of the facts based on their cause and effect relationships. To understand the facts, you need to ask questions to solve the problem at hand, to?Drill down with the W's?(where, when, why, which, what, who), to garner more facts to make an educated decision. Drilling down enables problem solving. The key element in processing your plan will be ensuring that everyone knows the right questions to ask to effectively manage the process.

Let's take a real life example of what happens when there is a lack of planning, ineffective decision-making and a lack of understanding of cause and effect relationships. During my luncheon with Warren, a business associate he lamented to me about his profitability and how it was down due to his excessive workers compensation insurance costs. After asking him a few questions regarding his payroll expenditures, history of accidents and the work being performed by his employees, I suggested that he talk with his insurance agent about his code classifications, as based on some quick math I knew that he was probably being charged the wrong code class. About two weeks later, I saw Warren with a big smile on his face as he told me he was getting a $63,000 refund, as the code classes were indeed incorrect. I suggested to Warren that he not only review his costs but also his coverage, exclusions, level of risk, safety programs, etc.

Unfortunately, Warren didn't heed my advice, as the only fact that Warren cared about was that he had a $63,000 windfall. Two weeks later, Warren's smile was gone as his top supervisor was injured on the job in a freak accident that could have been prevented with some simple training and worst yet Warren learned that due to an exclusion in his policy the accident was not covered by insurance, which meant Warren's company was liable and had to foot the bill.

Warren is a classic example of someone who does reactive planning instead of proactive planning.

Warren did not take the time to meet with his insurance agent to create an insurance plan. If he had, in an hour or so he could have formulated a solid insurance program based on some simple planning.

To start, he should have had stated goals and objectives such as:

• Control insurance costs
• Minimize/limit company potential liability
• Increase productivity and employee motivation by ensuring a safe working environment
• Educate personnel as to job related hazards and how to prevent them
• Comply with OSHA standards

Let's drill down with the W's for a moment with one simple question, to which the answers will directly impact the action plans the company puts in place to achieve the above stated goals.

What are the claims that are excluded from coverage under the insurance policy?

Answer: the insurance policy will not pay any claims arising from the following:

• Any injury that does not result in a fatality or disability for 3 days subsequent to the accident
• Any non-fatal injury caused by an accident that is directly attributed to the influence of drinks or drugs, willful disobedience of an order that would have secured the workman's safety or willful removal or disregard of any safety device.
• Subcontractor liability (unless specifically declared)
• Certain occupational diseases (unless coverage is extended through a rider and extra premium).

Armed with these facts, Warren implemented some of the following policies and procedures within his company.

• Written employee policy manual
• Employee safety program including Red Cross training annually
• Insurance company safety audit
• Subcontractor insurance certificates

Warren learned the hard way that ignorance is not bliss and that proper prior planning prevents poor performance.

I use my FADE methodology to process the plan. It combines knowledge of the facts with a process to deliver informed decision making and a plan for success.

FADE is an acronym for:

Focus-establish goals and objectives (strategic, financial, operational and cultural)

Analyze-establish strategies for achieving goals and objectives, determine the critical success factors.

Develop-specific tactics and action plans with ownership and timelines

Execute-prioritize the timeline, manage the process and get it done.

If you don't execute you end up with a FAD, which typically doesn't last very long.

After the FADE process is complete, your management team and employees should be able to execute the plan. They should be able to say "I know how to do my job", "I know how my job impacts the success of the organization" and "I have the tools to be successful".

Let's take another real life example of what happens when the tools are missing.

In working with a growing company that lacked both the requisite operational and financial tools to enable them to make better decisions, I noted that the COO had approved an operating lease for some IBM equipment at a cost of $100,000 per year. The equipment was to be used to teach IBM training courses. The budgeted revenue that the company expected to derive from the training courses was $250,000. The expected gross margin % to be earned from teaching the courses (revenues less direct operating costs to teach the courses) excluding the cost of the equipment was expected to be 18%, yielding $45,000 of gross margin. Because there was no prospective/proactive accountability the COO didn't analyze the facts to cost justify the purchase decision before he signed the $100,000 equipment lease. The result: a negative gross margin on the business of $55,000.

How could this poor decision been prevented from happening?

There are a number of ways. Why not start by incorporating checklists or other mechanisms into your daily operations. For example, I'm always amazed when I review a purchase order at the amount of information that is captured to ensure the purchase is properly accounted for to enable historical reporting, yet the lack of information that exists to justify the purchase: what is the payback period for the purchase, ROI justification in quantitative terms (expected impact on profitability), etc.

Start by educating your personnel:

• Establish goals with them.
• Provide performance measures that provide linkages to reward.
• Tell them which facts to account for and provide them with a process for analyzing the facts.
• Lay out the operating guidelines both quantitative (operational productivity, payback period, profitability, return on investment, cash flow, impact on earnings per share) and qualitative (customer satisfaction, employee satisfaction) to empower them to make more informed and sounder operational decisions.

In a well-run organization all employees should know the plan:

What financial goals matter?

• Revenue growth
• Market growth
• Profitability
• Cash flow

What matters operationally?

• Cost reduction
• Customer support and satisfaction
• Quality
• Cycle time or productivity
• Capacity utilization

Other areas where the organization needs to communicate the plan are:

• Capital expenditures and capital budgeting
• Selection of suppliers
• Investment in employees, processes, technology and innovation
• Mergers and acquisitions strategy, targeting, pricing, integration, planning, etc.

Let's review what happens when one of your employees, a top sales person does not have the tools or understanding of the company's financial goals and when those goals run counter to his personal goals.

Your top sales person is ecstatic. He just booked the sale of $2 million software license agreement with XYZ Corporation. The sale was at list price when the typical discount had been 30%, however to get the price he did have to include 1 year of software support and maintenance (typically at 15% of list), payment terms for the license agreement over 15 months at $400,000 paid each quarter for the next 5 quarters, but he also agreed to 2 months of custom development work for 4 developers at full billing rates.

He tells a fellow sales person that he could have booked the sale at a 30% discount with 90-day payment terms, pricing maintenance separately, and that they didn't need the custom development work right away but he closed the deal by throwing it in. Also, since his commission plan is based on gross software license revenue and he doesn't get paid for maintenance revenue he will make 30% more in commissions.

Let's take a quick look at some of the facts that will impact the organization in this example.

• Revenue growth will be substantially impacted by accounting revenue recognition rules thus impacting profitability and earnings per share. The company will miss Wall Street expectations, decreasing the stock price and further impacting their compliance with their line of credit thus impacting their borrowing availability.
• Cash payment terms impact cash available for working capital and to fund operations impacting vendor relations as accounts payable will be paid more slowly.
• Product development is overworked and does not have the manpower to staff the custom development effort. The Vice President of Development recently informed them that there would be no more custom development projects without his authorization, which he did not intend to give. He has lost all credibility. Since the stock price is down, many stock options are underwater and the morale of development personnel is now at an all time low.

Let's review why this happened?

The sales person was not empowered with the rules or have the tools. He lacked:

• A clear understanding of the organization's financial goals. He needed a structured plan with pricing policies and procedures defined as to how he would help attain those goals.
• A clear understanding of the status of the development organization and their lack of availability.
• An understanding of revenue recognition guidelines under generally accepted accounting principles or he would have known that the deal structure was not a beneficial one.
• Performance measures that tied the right linkages to rewards.

The organization needs to establish:

• New customer guidelines regarding payment policies and procedures.
• Checks and balances with the finance function to ensure all proposals are approved prior to presentation to customer prospect.
• An approval process for custom development projects whereby the Vice President of Development has to sign-off
• A better incentive compensation program

In summary, it is easy to see that ignorance is not bliss; that knowledge is the power to innovate and create. Decagon Partners helps our clients account for their future and maximize their future value through fact-based analysis and our FADE process.

Specific areas where we can help you include:

• Organizational assessment?- finding and identifying the real organizational problems, formulating what needs to be done and partnering with the management team to develop consensus for the action plans.
• Strategic Planning?- partnering with the management team to establish goals, objectives, ownership, measurement mechanisms and timelines
• Organizational Analysis and Design?- develop organizational solutions to improve the efficiency and effectiveness of the organization.
• Customer facing strategies?(sales, pricing, marketing, channel development, business development, etc.)
• Profitability?- productivity, process and quality improvement programs
• Mergers and Acquisitions?- strategy, due diligence, valuation and integration,

Remember, a man with a plan beats a man without a plan more often; so plan the process and process the plan.