My issue with Accountants (and their metrics)

Newsletter #20

Exciting times! I launched my first digital product!

If you’ve been reading my newsletter, I assume you’re interested in learning more about finance and how to use this in (your) business.

This series (product) covers exactly that and has some exclusive takes:

• How a Fractional CFO approaches finance

• How to improve the finances (profits!) of your business

• How to create a “healthy” business

And as this is my first-ever launch, I decided to be nice on the pricing ; )

You can find all details by clicking on the page below:

And to thank you even more for reading my newsletter, here’s a 15% discount code: FINANCIALROOTS15

Last note, I promised I would give 2 editions away to people who gave some suggestions. I received more than two replies, so my apologies to those who did not win (as a consolation, I also emailed you a 50% discount code!)

But the (randomly picked) winners:

• Rowan Marshall

• Sian Jones

Thanks again- I’ve emailed you separately!!

With this series out of the way, I again have the mental space to do something new.

And what better way to stay busy than to pick some fights 🥊.

This week, I want to take on the accountants (and their metrics).

In my corner, I’ll bring Reginald Tomas Lee, who wrote a fantastic and much-underappreciated book:

This book made me take a very hard look at accounting principles. And it made me believe that:

• Accounting (Financial Statements) is for Reporting purposes

• Cash-Based Information is for Decision Making

I know that’s vague, so hear me out…

All the Financial aspects of your business are eventually based on cash (and come down to the transactions in your bank account).

But this is pretty difficult to work with. And thus we categorise everything in bookkeeping software. That’s great.

Next, we realise that there is a lot that goes on in the business outside of the actual cash transactions…

Think about invoices you send out or receive with 30-day payment terms. Or inventory you buy but do not sell for months. Or land, buildings, and machinery you buy and then use (depreciate) over 10+ years. We need to track this too.

And that is what accounting is about. Based on the Accounting Principles, we can recognise revenue before cash is received, depreciate assets over time, and match costs (inventory) to the period in which it is used. And this is still excellent! But… it’s excellent for reporting.

The issue comes when we now start using this “adjusted” information to calculate some common Accounting Metrics:

• Fixed Costs

• Variable Costs

• Contribution Margins

❌ The problem is that we often think that this represents cash and that they vary with "volume"

✅ But the reality is that a lot of this is not cash, and it should vary with what you "buy"

Here's an example:

Let's say you grow tulips 🌷 

You might 'calculate' that it costs you 10 cents to grow one tulip.

This 'includes':

• Fixed costs like land and leases

• Variable costs like labour and energy

But do you 'spend' 10 cents every time you grow one more tulip?

No.

The 10 cents is an estimate. What if one week you are sick? Will you adjust this estimate?

Besides, you pay employees a salary for X hours of work, whether this gets you 100 or 200 tulips.

This forms a real issue when you start using it in your planning and marketing...

Because let's assume the 10 cent is accurate.

Case 1: You're now offered 14 cents per tulip. Will you take it?

Sales: Yes!

Reality: important cash outflows like inventory investments or debt repayments are likely not included in these 10 cents. And often neither are general costs like HR and Tech.

So, it is not really helpful for sales decisions.

Case 2: Somebody offers 20 cents per tulip and wants 1000 tulips.

Sales: Yes!!

Reality: your 10 cents does not say you only have the capacity for 750 tulips.

So now you rent more land for $1000.

Not so profitable again!

✅ Alternative: think in Cash and Capacity.

In other words: use the “information” you have available before the accounting calculations and adjustments are made.

Cash:

• Look at your total cash outflows

• This is what you spend on everything... HR, rents, labour

• The total of this is what you need to 'offset' with sales

A sale at any price will help you offset your costs. The higher the better.

Capacity:

• This is your available land, building, labour etc.

• How many tulips can you grow before needing to expand?

Tracking this ensures you know what you can deliver. Because fixed costs alone won’t tell you how much you can do with it.

In my experience, looking at cash flow instead of accounting metrics makes everything simpler.

Because cost calculations often include factors that are not really cash. It can throw you off.

Rule of thumb: be careful with calculations that “mix units”. Something like Profit per Labour Cost mixes $ and Time. This means you have to make assumptions, which can throw you off.

Ultimately, cash is what matters.

I hope I was able to bring my point across!

Don’t get me wrong. I love accountants. I couldn’t do my work without them and many businesses would go bust hehe.

But sometimes we take things a little bit too far…

Best of the Week

This week a section from a pretty interesting book I’ve been reading.

It is quite similar to the post I shared here last week, but adds more context.

Takeaway: be very careful what “metrics” you decide to track. Focusing on something like a “cost reduction” or “delivery time” could result in lower quality and cutting corners!

Be careful of the dark side.

If you’ve made it to the end but didn’t yet fall for my product promotion- good luck resisting it twice ; )

Discount code (15% off): FINANCIALROOTS15

Just leaving this here in case

Hope you liked this edition and survived my promotions!!

Honesty only do it because I believe it can be useful ; )

Next week back to 100% free value.

Cheers all!

Joey