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You Can’t Afford Not to Spend Money on the Accounting Department

As a former CEO to some CEOs, this Blog is to my counterparts that “don’t know what you don’t know.”  I have seen time and time again closely held businesses that have experienced growth make the same mistakes over and over again. To the CEO that believes bookkeeping is a necessary fixed cost that should be minimized, here is a money making tip. You can’t afford not to spend money on the accounting department if you want to be successful.

The Big Mistake

Your company has grown over the years; you have experienced good times and maybe some bad times. Additionally, you have taken a nice paycheck and sometimes, some nice bonuses.  You got used to a certain life style. And you did all of this with a bookkeeper that does not cost you much.  But your company has grown. Still in the back of your mind, you know something tells you that you are not comfortable with your accounting records. But you elected to keep cost down for the bookkeeper and you do not spend much on accounting.

You Can't Afford Not to Spend Money on the Accounting Department

My Tax CPA Does It All

Maybe until now, some of you have your outside CPA that prepares your tax return also prepare year-end financials. This is not a knock-on tax preparers, but your CPA that prepares your tax return is an expert in one of many fields CPAs work in. For example, I am a CPA, but there is no way I would prepare my own tax return. Tax laws change way too often. I just want to maximize my deductions and pay my fair share of tax, but not more than that. That is why I have my tax CPA prepare the tax return.

But over the course of my career, I have found that most tax CPAs do not have operational expertise. They have not run a manufacturing or service business, nor have they had any P&L responsibility. The Tax CPA is considering accelerated depreciation, maximize expenses, etc. This is quite the opposite from a management set of financial statements. The role of the CPA Tax preparer is totally different from a “operational” CPA, Controller or even CFO.

Minimizing the Back Office For the Wrong Reasons

Most CEOs that I have worked with argue to minimize the cost of the back office. That includes the cost of preparing financial and accounting records. But think about this… The Securities and Exchange Commission (SEC) does not require public companies to prepare their financial statements according to Generally Accepted Accounting Principles (GAAP) because they pulled this out of thin air as another way to regulate.  The SEC requires public companies to prepare their accounting records and financial statements based on GAAP because it is the best way to present fairly the results of your financial operations to third parties reading your financial statements.  In other words, It’s the RIGHT way to keep your books!

In some cases where there is significant debt and exposure, some banks also require that the company present your accounting records based on GAAP – regardless of whether it is a Public or Private company.  Some debt situations even require an audit. The banks simply make it one of the covenants related to your debt. When you present your books and records per GAAP, you have accurate financial statements, everyone is assured your accounting is correct.


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The Importance of Using GAAP

So, if a lot of brain power has been put into coming up with GAAP, and the general consensus is that GAAP is the right way to present your financials and accounting records.  Why would you as CEO not require that your financial statements be presented per GAAP?

I have been an “operational” type CPA for over 27 years now. In addition, I have held the office of CEO twice. I have used my expertise in public company environments and private companies both as an employee and as a consultant in the U.S. and in other countries. I have seen many very successful small, medium and large private companies and they were all keeping their financial records per GAAP. Yet, I have NEVER seen a significant company (not a micro or small business) be successful and properly run without keeping their books and records per GAAP.

So why is it that CEO’s of closely held (private) business still permit their accounting records to be kept some other way?   The answer: they do not want to spend money on a fixed cost such as accounting. But they will spend money on the sales team, hunting leases, extravagant meals or parties.

Not getting the basics down – such as GAAP – leaves money on the table when you are exiting the company. Increase value with our Top 10 Destroyers of Value whitepaper.

You Can't Afford Not to Spend Money on the Accounting Department

You Can’t Afford Not to Spend Money on the Accounting Department

These are real life examples and outcomes of minimizing the cost of your accounting department that I have lived…

The service company incorrectly books gains on U.S. dollar receivables. In conclusion, they had to reverse $8 million from earnings.

I have seen this one several times. The company does not have some large assets on the balance sheet, because their tax preparer said they used accelerated depreciation. As a result, the balance sheet assets are severely understated. Hint: your value is understated. IT’S ABOUT THE MONEY DUDE!

The manufacturing facility does not properly accrue costs. As a result, their margins are way off, and the CEO wondered why they were always short on cash.

The company did not properly reconcile accounts including cash. This led to fraud.

The company did not properly recognize revenue. In conclusion, the company was understating revenue by millions of dollars.

I can go on and on with more real-life examples.

If you do not have your financial statements presented per GAAP, how are they prepared and presented? Do you really know your margins in your P&L. Do you really have all your assets, liabilities and equity presented correctly? Is your P&L, Balance Sheet and Cash Flow statement presented correctly? Guess what? Your ratios that your controller or CFO should be analyzing are not correct.

Leadership Needs to Believe in GAAP

Why do you think Exxon, Walmart and all other public company CEO’s believe in GAAP?  I have also seen many small, medium and large closely held private companies keep their accounting records per GAAP.  These are all successful companies. They know their margins, they know where cash is, they know their ratios and guess what, they know how to forecast!

I have also seen time and time again good companies that have been around a while and have experienced growth, and NOT prepare their financials per GAAP.  And every one of these CEO’s and companies has the exact same issues.

  • They really don’t know their margins in their P&L
  • Some companies don’t even really know their actual revenue
  • There is always that doubt in the CEO’s mind as to what is really going on in the business
  • The CEO lives a stressful life
  • Every time there is even the slightest decrease in margins, there is even a bigger disproportionate stress on cash
  • If your books are not per GAAP, then most likely they are not on the accrual basis; if that is the case, then you are 60-90 days behind your business
  • Having your books on an accrual basis is just the first step. There are many other accounting rules, procedures and pronouncements to get your books per GAAP. Just because they are on accrual basis, does not mean they are per GAAP. GAAP “rules” actually change frequently

You Can't Afford Not to Spend Money on the Accounting Department

In Summary

In my consulting business, I have seen CEOs that are “smart” as in they know what they don’t know. They bring us in to get the problem fixed. Although it takes time and money, the CEO is fully supportive and we get it done. These are the companies that grow and ultimately have a successful liquidation event. Or they leave a well-run machine to their family or employees.

But it shocks me to continue to see companies as large as $120 million in revenue, with a couple hundred employees that have not professionalized their accounting department. No one knows the true margins. Everyone stresses out about the “accounting records.” There are no correct historical financials, and most certainly, there are no forecasts. Unfortunately, there is no analysis of the business at all. In some high margin “hot” industries, this works for a while. The sins are buried. But millions of dollars are lost without knowing it. But, since ultimately everything ends up in cash, when that “hot” industry has even a slight downturn, the CEO feels the cash crunch.

Whether you are trying to increase the value of your company or positioning it for sale, this issue of unknowingly leaking cash is a destroyer. Learn how to tighten your belts and increase value with our Top 10 Destroyers of Value whitepaper.

Don’t be Cheap

Don’t be cheap. Spend the money (which is usually less than the hunting lease) to get your books and records based on GAAP basis.  Get your priorities straight.  Continue to have a professional accounting department in your business. YES, you will spend more than you are currently spending. But you can’t afford not to spend money on the accounting department!

Consider this… I had one investment banker with a very large firm tell me the difference in a valuation of an acquisition target from a company that has accounting records per GAAP and solid accounting department versus one that does not have a professional accounting department and accounting records not per GAAP is a difference of 20%-30%.  I had another investment banker tell me the difference in valuation is “one turn of EBITDA”. The use of EBITDA and multipliers is often used in valuation.

So if your company generates $2 million EBITDA and the multiple used is a 5, then your value would be $10 million with a professional accounting department and books per GAAP. In comparison, your value is $8 million with an unsophisticated accounting department and accounting records not per GAAP. I don’t think your professional accounting department will ever cost you $2 million per year! But not having it will.

Not having your financial records per GAAP is one of the destroyers of value. If you want to protect the value of your company, download the free Top 10 Destroyers of Value whitepaper to learn how to maximize your value.

You Can't Afford Not to Spend Money on the Accounting DepartmentYou Can't Afford Not to Spend Money on the Accounting Department

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Generally Accepted Accounting Principles (GAAP)

See Also:
Accrual Based Accounting
Modified Accelerated Cost Recovery System MACRS
10 Q
Asset
History of Accounting
Full Disclosure Principle

Generally Accepted Accounting Principles (GAAP) Definition

Generally Accepted Accounting Principles (GAAP) are a set of standards, guidelines, and regulations for financial accounting. Companies should follow GAAP rules when preparing financial statements.

GAAP rules were established to provide consistency in financial reporting and accounting practices. The rules evolve over time. Therefore, they reflect the most relevant and applicable accounting practices.

GAAP Meaning

Generally Accepted Accounting Principles (GAAP), in short, means the rules which provide the basis of all accounting decisions for financial institutions, businesses, and organizations. In the U.S., several organizations influence what GAAP rules, including the Financial Accounting Standards Board (FASB), the American Institute of Certified Public Accountants (AICPA), the Securities and Exchange Commission (SEC), and the Internal Revenue Service (IRS). U.S. GAAP differs from other international accounting standards, but organizations like FASB and the International Accounting Standards Board (IASB) are working to establish acceptable international accounting standards.

Overall, accountants calculate in two ways: for a financially stable or financially instable company. This is referred to as the Going Concern; unstable companies calculate assets by estimated value of the item when liquidated.

GAAP Standards

Generally Accepted Accounting Principles (GAAP) uses many standards and protective measures to ensure reliable and useful accounting statements. For example, accounting is done in fiscal periods which may not coincide with actual calendar periods. They instead coincide with the relevant events that happen to the company with respect to accounting standards.

Worst Case Scenario

Many GAAP standards account for the worst-case scenario. When you record past events in their value at the given time, call this the historical monetary unit. Additionally, subtractions from company cash are made when possible whereas additions are made only when the product is sent and cash is received.

Do Not Consider Intangibles

Under GAAP, do not consider intangible values, such as workforce knowledge or brand goodwill, an asset. Do not record these in the balance sheet. Furthermore, always make an effort towards consistency. Expectations like depreciation or inventory are accounted for in the same way across all periods which they occur. You must make any changes to one period, under this concept, to all periods past. Also, make these changes completely clear to the reader of the statement, providing the necessary background to understand the true meaning of the document.

Lastly, the scope of the company comes into play. An example of this would be a laptop computer: the accidental destruction of a single laptop means much more to a small business than a multinational one. The company scope is essential to relevant and readable financials.

GAAP Example

For example, Natalie is the CFO at a large, multinational corporation. Her work, hard and crucial, effects the decisions of the entire company. She must use Generally Accepted Accounting Principles (GAAP) to reflect company accounts very carefully to ensure the success of her employer.

Natalie begins her process of creating GAAP compliant statements. First, she looks at past records. These provide the crucial understanding of where her company has been. From here she can expand her accounting to meet the current and future needs of the company.

Natalie makes sure to to keep statements consistent. With the recent change in company policy from LIFO to FIFO, she has a lot of work ahead to correct past balances as well as make the change clear in the body text of the document.

When Natalie creates financials she ignores the value of the company name and brand, despite the fact that they sell a product which is in many ways a commodity. Her concern is tangible rather than intangible assets.

Bad News

Finally, the executive salesperson enters her office with the bad news that he has been in a car accident with the company car. The accident destroyed the vehicle beyond repair. Though Natalie is concerned for the health of her co-worker she is not concerned with the value of the vehicle: with a vehicle fleet valued at over $25 million a single car is not the concern of Natalie.

Natalie finally completes her assignment. She has faith in her work due to her training and expertise in her field. She has confidence that she has prepared sound GAAP complaint statements.

If you want to add more value to your organization, then click here to download the Know Your Economics Worksheet.

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Securities Exchange Act of 1934

See Also:
Secondary Market
Securities Act of 1933
New York Stock Exchange (NYSE)
Primary Market
Sarbanes Oxley Act of 2002 (SOX)

Securities Exchange Act of 1934

The Securities Exchange Act of 1934 deals with the regulation of secondary market transactions, or outstanding securities in the market (which can be traded on a daily basis). The Securities and Exchange Commission (SEC) regulates this act.

Securities Exchange Act of 1934 Meaning

The Securities Exchange Act of 1934 was established after the stock market crash of 1929 – the following Great Depression. The 1934 Securities Exchange Act is meant to provide meaningful and relevant information to the average investor. This ensures that the investor is not mislead in anyway so that they are able to make well informed decisions. The Securities Exchange Act regulations include the need for quarterly and annual audits by an accounting firm. These accounting firms then attest to the accuracy of the statements.

The Securities Exchange Act of 1934 thus ensures that there is no fraud that exist within the company. It also deals with insider trading. If an investor has information that is non-public in nature then, then under the 1934 Securities Exchange Act, he/she may not act on it until the information has gone public. The idea is to provide a fair and equal market so there are no unusual transactions to set the market adrift.

securities exchange act of 1934

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Securities and Exchange Commission (SEC)

See Also:
New York Stock Exchange (NYSE)
Generally Accepted Accounting Principles (GAAP)
American Institute of Certified Public Accountants – AICPA
Financial Accounting Standards Board (FASB)
Full Disclosure Principle
Corporate Veil
Investment Banks
Treasury Stock
Accounting Fraud Targeted

Securities and Exchange Commission (SEC) Definition

The Securities and Exchange Commission (SEC) is a U.S. government agency that is responsible for protecting the well being of investors. The SEC performs this function by regulating securities whether it is public company stocks, bonds, or any other security issued into the U.S. market.

Securities and Exchange Commission (SEC) Meaning

The Securities and Exchange Commission was created in 1934 to try and rid the market of unfair or corrupt practices. This meant that all publicly traded companies had to present audited financial statements, and meet all other requirements that the SEC established. The idea is to protect the everyday investor who does not have extensive knowledge of markets or securities. Five commissioners operate the SEC, and the President of the United States appoints them. Furthermore, a requirement is that there can only be three members at the most from a single political party. The President also appoints one of these members to be a chairman; however, no one is able to fire them once the President appoints these commissioners. This allows the commissioners to operate in the best interest of the people without worrying about losing his/her job.

Four Divisions of SEC

The SEC has four main divisions Corporation Finance, Trading and Markets, Investment Management, and Enforcement. Each of these has a separate responsibility towards certain securities and how they are offered into the market. Overall, the Securities and Exchange Commission duties have been performed up to par. However, there have been times in which fraud or insider trading has been routed out meaning that the SEC must amend what it is doing to try and avoid the same problems in the future and protect investors.

If you want to overcome obstacles and prepare how your company is going to react to external factors, then download your free External Analysis whitepaper.

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Secondary Market Definition

See Also:
Securities Exchange Act of 1934
Secondary Market
Primary Market
Securities Act of 1933
New York Stock Exchange (NYSE)

Secondary Market Definition

A secondary market definition is the trading of already issued securities – the primary market. Furthermore, the Securities Exchange Act of 1934 regulates these securities.

Secondary Market Meaning

Many know secondary markets better than the primary markets. This is because the secondary markets are more readily available to the average investor. They are also often in the form of exchanges. The New York Stock Exchange (NYSE) or the National Association of Securities Dealers Automated Quotations (NASDAQ) are examples of this type of exchange. Then, these are regulated by the Securities and Exchange Commission (SEC) under the 1934 Act of Securities Exchange. Furthermore, this is to ensure the accuracy of the companies whose securities are trading on the market.

If you want to overcome obstacles and prepare how your company is going to react to external factors, then download your free External Analysis whitepaper.

secondary market definition

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Private Placement

See Also:
Convertible Debt Instrument
Common Stock Definition
Preferred Stocks
Hedging Risk
Treasury Stock

Private Placement Definition

The private placement definition is the process of raising capital directly from institutional investors. A company that does not have access to or does not wish to make use of public capital markets can issue stocks, bonds, or other financial instruments directly to institutional investors. Institutional investors include the following:

You do not have to register private placement issuances with the Securities and Exchange Commission (SEC). In addition, you do not have to provide a detailed prospectus. The issuing company and the purchasing investors negotiates the terms and conditions are negotiated. You cannot trade private placement securities on public markets, but they can be traded privately among institutional investors after they have been issued by the issuing company.

A private placement is in contrast to a public offering, which is issued in public capital markets, requires a detailed prospectus, must be registered with the SEC, and can be traded by the investing public in the secondary markets.

Advantages and Disadvantages of Private Placement

The primary advantage of the private placement is that it bypasses the stringent regulatory requirements of a public offering. You have to conduct public offerings in accordance with SEC regulations; however, investors and the issuing company privately negotiate the private placements. Furthermore, they do not have to register with the SEC, do not require the issuing company to publicly disclose its financial statements, and ultimately avoid the scrutiny of the SEC.

Another advantage of private placement is the reduced time of issuance and the reduced costs of issuance. Issuing securities publicly can be time-consuming and may require certain expenses. It forgoes the time and costs that come with a public offering.

Also, because the investors and the issuing company privately negotiate private placements, they can be tailored to meet the financing needs of the company and the investing needs of the investor. This gives both parties a degree of flexibility.

Now, let’s look at the disadvantages of private placement. The main disadvantage of private placement is the issuer will often have to pay higher interest rates on the debt issuance or offer the equity shares at a discount to the market value. This makes the deal attractive to the institutional investor purchasing the securities.

If you want more tips on how to improve cash flow, then click here to access our 25 Ways to Improve Cash Flow whitepaper.

Private Placement, Disadvantages of Private Placement, Private Placement Definition
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Private Placement, Disadvantages of Private Placement, Private Placement Definition

 

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Insider Trading

See Also:
Blue Sky Laws
Subscription (Preemptive) Rights
Accounting Fraud Prevention using QuickBooks
Binomial Options Pricing Model
Black Scholes Option Calculation

Insider Trading Defined

Insider trading is buying or selling stock based on nonpublic information that will affect the stock’s price. A company’s executives and directors have access to significant information regarding the company’s activities. These people could easily profit by buying or selling the stock based on the private information they have. However, doing so is illegal.

SEC regulations prohibits insider trading, in certain circumstances. The idea is that trading based on private information is unfair. If insider trading were legal, then insiders could make huge profits by buying or selling a company’s stock just before important information is made available to the public. This behavior would put the investing public at a tremendous disadvantage in terms of buying and selling financial securities.

Insider trading is not always illegal. Typically, someone labeled an insider will have designated windows of opportunity throughout the year in which to legally buy or sell the company’s stock. Executives and managers are often awarded stock options, CEOs and directors often own significant amounts of their company’s stock. These people should be able to buy and sell their stock. And they can, but they must do it according to the rules. Insiders must notify the SEC regarding their buying and selling transactions.

Under certain conditions, if an executive announces publicly that he will sell a certain amount of shares or value of stock at a specified date every year, then he may do so each year without it being considered illegal insider trading. Likewise, managers or executives with access to nonpublic information may buy or sell stock after that information has been made available to the public.

Insider Trading Example

For example, imagine an executive at a large publicly traded corporation who sees the company’s income statement before it is issued to the public via the annual report. The executive sees that the corporation suffered big losses in the current period. Once the Wall Street analysts see these numbers, the company will be downgraded. Thus, the stock will decline.

If insider trading were allowed, then the executive could quickly go out and sell the company’s stock short, or else he could tell his broker and his friends and family members to sell the stock short. Selling a stock short makes a profit when the stock price goes down. When the reports are finally made public, the stock will plummet. Then the executive and his friends and family all make a lot of money. Meanwhile, the investors who owned the company’s stock but did not have access to the private information suffered losses.

Who is an Insider?

Technically, an insider is anyone who has access to material nonpublic information regarding a company. Examples of insiders include executives, directors, managers, shareholders with a 10% or greater stake in the company, and the close family members of these people. Insiders may also include lawyers, brokers, investment bankers, and printers of financial documents. It is illegal for insiders to buy or sell a stock based on material nonpublic information.

What is Insider Information?

Inside information is any material nonpublic information regarding a company that could affect the company’s stock price. The information is nonpublic if not yet disclosed to the investing public. The information is material if its disclosure could impact the company’s stock price. Examples of insider information include access to unreleased earnings reports, knowledge of a pending or imminent takeover or merger, or knowledge of any other kind that is of value to investors.

Download your free External Analysis whitepaper that guides you through overcoming obstacles and preparing how your company is going to react to external factors.

Insider Trading

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