Your Books Are a Mess! How Inaccurate Books Impact Business

[00:00:00.900] - Dan

Hello, and welcome to Books and the biz. We are back again. Rich, how are you doing?

[00:00:13.420] - Rich

I am good. How are you?

[00:00:15.120] - Dan

I am wonderful. Today we are in Rich's world. I get to play in Rich's mind for the next half hour or so, as we are talking about finances. So here's what prompted us, I guess, to talk about this. So Rich, I was talking with you earlier about a situation where working with a company fairly well established. They've been around for a number of years and started going through their information financially and found out things were really screwed up. They were putting money in their P&Ls that were supposed to be in the balance sheets. They had stuff in the balance sheets that wasn't supposed to be in the balance sheets, and they really weren't tracking things properly. And you have to wonder in some cases how this gets by, because they have to file taxes and it has to go in front of an accountant. But sometimes people do their own stuff, and maybe the accountant doesn't see where they put things, and that can be a problem. So I thought this would be an interesting discussion, because I think most of the companies we deal with have been established. They're pretty good size. They've got decent financials.

[00:01:31.270] - Dan

But that doesn't mean mistakes can't be made. Or maybe again, the owner just doesn't know what their business is doing financially. Because I know a number of companies where I talk to the owner and say, Well, when was the last time you looked at your P&Ls? Pretty much never. Never? What do you mean never? How can you never look at your P&Ls? Well, I just checked the checking account, and if there's money in the checking account, we must be profitable, right? And this is where I turn it over to you because now I'll get you on your soapbox and let you go.

[00:02:04.840] - Rich

Well, yeah, I've come across a lot of that where I'll tell you a story from probably 20 years ago. I had someone I walked in and we were talking about his business and I asked how he was doing and he says, I operate the business on a barrel theory. I'm sitting there looking for a textbook. I'm like, Where is barrel theory? I've never heard of this before. What is the barrel theory? I had to ask him, What are you talking about? And he says, Well, I take all the money that comes in and I put it in a barrel and then I take the money out of the barrel when I have to pay expenses. At the end of the day, if there's money at the bottom of the barrel, I did good.

[00:02:44.450] - Dan

Well, I guess that can work in certain situations.

[00:02:48.670] - Rich

Well, let's put it this way, flash forward five or so years later and he's in bankruptcy court.

[00:02:55.650] - Dan

I guess his barrel finally emptied out. There was a hole in the bucket, Dear Liza, Dear Liza.

[00:03:00.510] - Rich

The barrel ran out. The barrel definitely ran out. But the funny part was there's other things that go into it. It's not just money in, money out. There's other pieces to it and how you report it. And as you mentioned, taxes. When we look at the rules around financial statements, there are technically four or five of them, depending on who you talk to. An audited financial statement has five because you get an audit report at the front that says, We're responsible for looking at your numbers and we don't see anything that would tell you you're not going to be here next year. If you take that and you just say, I'm doing everything internally, then there's four, which is balance sheet, PNL, cash flow, and the notes to the financial statements, which is usually explanatory language. But usually if you go in and you ask people, can you show me your financials? They give you one of them.

[00:03:53.360] - Rich

It's usually the PNL, might be just for the year.

[00:03:58.860] - Dan

And then.

[00:03:59.900] - Rich

You're looking at it scratching your head a little bit because you realize from someone that has looked at them for a long time, you realize there are things in there you can't possibly figure out just from one statement.

[00:04:12.160] - Dan

Exactly.

[00:04:13.190] - Rich

And so you get into a lot of question marks. You start to ask, well, are you on the cash basis, which would be the barrel theory? Or are you on the accrual basis, which the difference is your revenues and expenses in accrual basis are done when they are earned or incurred, not when they're collected or paid out.

[00:04:35.930] - Dan

Now, when would a company be on one versus the other? Does it depend on industry or how does that work?

[00:04:41.880] - Rich

Well, generally accepted accounting principles do not accept cash basis. They almost automatically go to accrual. Now, if you're talking about taxes, it's usually the size of your business that will determine whether or not you can stay on cash basis or not. If you're a corp, I think it was it used to be five million. I want to say it's 10 million now. Those are tax rules. But I think the other thing is certain types of entities, like if you're in a partnership and everybody who owns the partnership are individuals, individuals are always on the cash basis. So the partnership might be allowed to stay on the cash basis because all its owners are on the cash basis. So there's definite issues of what is your... What's your status? What did you elect to do? And in a lot of cases, if they're on the cash basis, I get a little worried because it doesn't tell you what are you owed and what do you owe. So your accounts receivable and accounts payable are just missing. Right. So you wind up on a cash basis. You could show people that I'm doing great, but you have a pile of payables that are on your bookkeeper's desk that are not getting paid, but they're not in your books either.

[00:05:59.850] - Rich

There. So there's no record of what these pieces of paper are. So if somebody buys your business based on that financial, those payables are due. Yes. So they won't know about them. And then you're in for a pretty shocking surprise when that guy comes back and says, I bought your business and now I owe a lot of the money. You had to kick in here. So it worries me a bit when I start hearing about people who hand out one financial and maybe it's just not detailed enough. We used to always joke that financial can't just be revenue, expenses, net.

[00:06:43.650] - Dan

But for most people it is. And the fun part is, again, I'm typically not the financial guy. However, from an operations side, I do have to understand what's going on financially in a lot of cases and where they're spending money. And the fun part is when you pull up that, they finally get the PNLs, so they contact their accountant, because here's the other mistake that they have. They should have it with the accountant where the accountant is sending that information every month by a certain date. And that's one of the first things I implement when I'm talking with my clients is you need to get your financial records no later than I typically say the 10th of the month. Sometimes it's a little bit later than that. But usually by the 10th, you should have all your books balanced out and reconciled, and they should be able to give you fairly accurate statements, even if they aren't fully complete for the previous month. But most of these guys, again, they don't get in the habit of that. This is where the accounts to me make one of the biggest mistakes, is they should just have that built in.

[00:07:43.990] - Dan

Yes, charge for it. I tell the accountants, I'm your best friend because I'm going to ask for stuff that you can bill for. And you should be doing this already. Why are you not providing this information? Because it's so important to the business. I'm going to pull this up here, Rich. This is one of the... I pulled up some articles that we reviewed through this. But here's one, for example, a firm wrong numbers the risk of inaccurate financial statements. And I know you've read through some of these, but it's so important to have accurate information because you think, well, what's the dollar here? What's the dollar there? What's the difference between cash versus accrual? How much money is my bank account really? Is all that matters? That's really not the case.

[00:08:33.980] - Rich

Twenty-five plus years ago, when computers were foreign, when they just weren't available, things were moving at a different pace. Computers came in and over the last 20 years they have accelerated everything from decision making to financing requirements. Everything becomes a much faster paced environment for management to have to make decisions. How do you make decisions without the financials coming out as fast? Even if it's not a full blown financial, even if it's just the key data that says we're going to make a decision on something that's going to affect us this way, you need to have that available at your fingertips. And like I said, everything is moving that much faster. You have to make those decisions quickly. So leaving the financials to, Well, my account is coming in the end of the year. It's dead information at that point.

[00:09:36.720] - Dan

It's past, it's old.

[00:09:38.620] - Dan

It's stale. And I give an example.

[00:09:44.030] - Rich

I.

[00:09:44.880] - Rich

Used to do the monthly reports for one of my companies that had a parent in Germany. And so they had to report to Germany within days. The 10 days wouldn't have been acceptable. They would have gotten in trouble for 10 days. So they had to get up faster. The interesting part was when we hit 2007, 2008 in that time frame where the Great Recession started, when I put the numbers together, the first thing I asked them was, What's going on with inventory? They had an inventory that was climbing and they didn't realize that it was climbing. They at the end of the year, usually had to ramp up the amount of inventory they had in the warehouse because there would come a point where they couldn't get shipments because of the holidays.

[00:10:34.210] - Rich

There.

[00:10:35.020] - Rich

Was a delay. They always knew we had a ramp up on inventory. But what they didn't realize was all their orders were being canceled because the companies that they were shipping to were no longer looking at the forecast that they had given them. They were saying, We don't need this anymore because our volume is going down. So all of a sudden you ask, What's going on with the inventory? And everybody says, Oh, wait a minute. We never canceled our orders, even though they canceled theirs. So our customers were canceling. We didn't cancel from deliveries that were coming from our parent. So we had to get on the phone and basically start looking at our financials with the parent and go over the fact that I now have plenty of inventory I may not be ordering for months. And that's what it turned out to be. Actually, it took us eight, nine months, I think, to really put inventory back into a level that was normal. But had we not looked at the financials, we might have kept going. We might have had a massive amount of inventory in that warehouse that could go stale because there is a shelf life on certain things.

[00:11:43.580] - Dan

Exactly. Well, I know in a lot of cases, and this is true of manufacturing, but it's true in a lot of other businesses, there's things that are just automatically ordered and most people don't pay attention to. Think of subscription software, for example. This is probably true with more smaller companies. But basically everything is subscription now. You don't go to Best Buy or Staples and buy your CRM software or your accounting software. It's all pretty much online and you pay a monthly fee to access it. Well, what if you're using software or what if you're getting supplies that you get an automatic shipment every month, or you got that software that pays a monthly fee? Actually, I just had a client myself that they were wondering why their cash was so low when their sales were so high. They started going through their books, and they started realizing they had all these automatic payments going out for whether it was software, whether it was equipment, whatever it might be, and they weren't tracking it. They actually sat down for 2-3 days and went through line by line and found where everything was at, and it was pretty significant savings.

[00:12:52.750] - Dan

You don't realize how often you get things set up automatically because you're not checking the financial is not paying attention to it, it's not until you get into trouble that you realize there's a problem.

[00:13:07.150] - Rich

Yeah. Then on top of that, segue that into why is your cash down? What's going on with your receivables?

[00:13:19.260] - Rich

What's.

[00:13:19.910] - Rich

Going on with your collection activities? Are you actually collecting your money? There's too many clients that I've seen that are not collecting their money, which is really shocking to me because nine times out of 10, when you ask an owner for financials, they'll tell you 100% off the top of their head what their receivables are and what their sales are. They will know those numbers and probably the cash balance. But that's only three numbers in a matter of, like I said, there's four full statements, but they'll tell you those three pretty fast. So that's when you know that's what they're tracking. They're not tracking financials, they're tracking three pieces of financial data. And now you I have to teach you or basically I have to coach you that those three are not enough, that there's other issues.

[00:14:06.830] - Rich

Well, especially the cash flow one. I'm thinking of a client that I have. She's set up where she's working with this company. She's a sub of that company. They're a sub of another company. And she's performing work. She is billing for the work, but they are carrying her for anywhere from 3-6 months. And that's just insane to me. And again, she's looking at one number saying, well, gosh, I should have all this money in my account. I'm like, well, why don't you? Let's look at some of the other numbers. And we look at the cash flow statements and you realize that she's already set up for 30-day terms, but those 30-day terms are based on when her client gets paid. And again, they're a sub of another client. So if they don't get paid for three months, it's three months plus 30 days for her. She's now out for four months before she sees a dollar. She's already paid her employees. She's already paid for the software to create the technology and all this other stuff.

[00:15:12.460] - Rich

Yeah. Well, I would argue, like I said, you go to a founder, more often than not, they're going to tell you what their receivables are. They're going to tell you what their cash balance is, what their sales to date are for the year. Probably they have that number.

[00:15:29.190] - Rich

Ask.

[00:15:30.020] - Rich

Them what their payable balance is. I can guarantee you they don't know. The funny part is too, if you actually get into their software and take a look, you'd be surprised. But there's a fair number of companies out there. The smaller they are, there's no payables in there at all. They don't track them. But I would argue in the financial statements, there's one number that I think is probably the most important number in all the financial statements. I would tell you it's on the cash flow statement, and it is the cash flow from operations. Probably the most telling number of any financial you want to go look at a company that you're just going to look, whether it's an acquisition target, whether it's a client. For me, I always want to see what is that number. And the reason I want to see that number is that tells me whether or not your operations, meaning your sales of your product or your sales of your service, are you covering your operational expenses with the money that you're collecting? If that number is negative, we have some digging to do. If that number is positive, is it sufficient enough to cover the loan payments that are in the finance section or the purchases of CaPEx that are in the operating section?

[00:16:44.620] - Rich

So thatThat one number is probably the first number I look for in any company that I'm looking at their financial statements.

[00:16:51.910] - Dan

That's a very good point. How many times do you find a company that isn't even covering their operating expenses? I find that time and time again, and I'm like, You need to raise your prices. You're not charging enough. Also you need to collect quicker. You're not collecting fast enough. Then you go through this whole process of, Oh, I can't raise my prices for this, or I can't raise my prices for that. I'm like, Well, then good, you're out of business. Because if you can't collect at least enough to cover your operational costs, you're in trouble. And as you point out, that's just one variable. You got the loans, you got the other stuff that you got to include as well.

[00:17:28.980] - Rich

Yeah. And you really have to know. And that's where it also leads again to understanding your business. For example, if you're in healthcare and you're billing insurance companies, the bill that you send is not necessarily what you collect, because all the insurance deals and everything, that's why healthcare is so complicated. The complication of running a doctor's office or a clinic, the complication is in the billing. So the complication is in the collections. It's in the statistics around what you can build and what you can collect, and that will determine how much volume you have to do to keep up the office, to keep up the front office and the back office. How are you paying for nurses or assistants or people in your office that are doing the paperwork because there's a ton of paperwork in health care.

[00:18:20.410] - Rich

So if.

[00:18:21.700] - Rich

Your billing tells you you have to see 500 patients, you just figured out, hey, I'm only doing 400. I'm only 400 people. Well, then there's your issue because you can model that out and say, the only other way I can do it is I have to give away some expenses. I have to take away something that I can't spend money on. So all these things lead to those operational decisions. How many people can I have on staff in a given month if I'm only going to see this volume?

[00:18:55.440] - Dan

Actually, I appreciate you talking about that because I actually... The client that was dealing with the lag time on getting paid, we actually did that. We walked through those steps. And what we found out is she had to make something like, I think it was $400 an hour is what she had to generate for revenue. Based on the number of hours she was open, the number of employees she had, those employees had to be billable and combined had to bill at least at $400 an hour. Now there's people getting billed at different rates because they're doing different things. So you start adding those up and it's like, well, you need to, again, to keep these people busy for over 40 hours or add 40 hours a week, you have to have this person doing so much and this person doing so much. And you have to include your cost, your hourly rate in that. And it gets to be pretty significant pretty quick if you're not really measuring that out.

[00:19:53.960] - Rich

Yeah. I mean, it's basically a break even analysis. You're basically going back and looking at what volume do I have to do to get to this price? Because you can adjust that price and say, I can't do $400 an hour. People in the market will not pay $400 an hour. Okay, then you have a bigger volume that you have to get to because it's really that straightforward. It's the hourly rate times the number of hours. So you start again, the more you analyze your financials, the more data you are armed with to make the decision. If your client had not looked at those financials and not done that analysis with you, then all of a sudden it becomes a knee-jerk, here's what I have to do. I have to make this big decision and I'm just going to do it because this is what I feel.

[00:20:38.840] - Rich

There's no support for that. The only person to blame if it doesn't work is you and because you operated and made a decision based on lack of data, even though you have it.

[00:20:50.020] - Dan

Yep. Well, and going back to that whole cost thing, you mentioned maybe my clients can't afford $400 an hour. What I typically find is the opposite. They're charging well below what their competitors are charging, and it's creating all sorts of issues because they're not collecting enough money and they need to get back to where they're competitive. They don't need to be the most expensive person out there or company out there, but they do need to stay in market with what other people are doing. If you're going to be the lowest price, it's only a race to the bottom because somebody who's bigger, maybe has more resources and can cut fees in some way, or maybe they'll treat you as a loss leader, will lower the fees to get underneath you to then try and steal your business away only to raise those fees later on. You really do need to have a clear understanding of your numbers in order to make accurate decisions on how you should be billing, how you should be pricing, especially true with widgets. So if you're building something, you're machining something, you have to know how much that metal costs.

[00:21:57.510] - Dan

You have to know how much the materials to weld and cut, and laser and all that costs. Then you need to know your labor fees on top of it all. Basically gets down to then how much it costs to build that widget and how many widgets you can build in an hour.

[00:22:14.590] - Rich

Yeah. When I first started like, wow, that was a long time ago. But when I first started, I remember I worked in an office that everything was on paper. There were no computers. But he had a... The guy I was working for had a deli shop that was his client. Sure. Literally, they went in and figured out. They watched the guy making just an Italian sub. Basically, you got some ham, some lettuce, some tomatoes, some oil and vinegar. They looked at how much are you putting on every sandwich. The accountant finally looked at them and said, You got to charge, and this was years ago, so you got to charge $20 for that sandwich. I was like, No one's going to pay $20 for that sandwich. He said, Yeah, but you look how much stuff you put on that sandwich. It was a great sandwich, but he was putting too much materials in it. And the accountant was telling him, if we go through the analysis, this is what you find out. So it really does come down to everybody has the ability to do this. Everybody who's running a business should be getting enough data to be able to make these decisions.

[00:23:27.280] - Dan

And if you don't have people that are qualified to make those decisions, that's where you need to go to an outside resource because that outside resource will pay for itself in spades. Once you find out things like for the sandwich, you're putting too much meat on the sandwich, it's jumping your food costs through the roof. Well, nobody's going to pay $20 for it. Okay, well, then if it's $10 for that sandwich, you need to create a $10 sandwich, which means your % of food cost has to be X because the other % is labor, that's Y. Then Z is everything left over that covers overhead and profit.

[00:24:04.820] - Rich

Yeah. And it's funny too, because I'll jump industries for you for a second. But when I first started doing the type of work that I'm doing now, I had a client that was in a satellite telecom company. And I actually was working with him and he had financial statements. He was getting the data and he actually would come in and he'd get it every month from the office manager and it would be a balance sheet, PNL. I was impressed. But then he came to a point where he said, I don't understand why I'm not growing anymore. And he brought me in. And when I started looking at them, I said, This is great. I said, here's the problem. I said, You have 10 different routes that you're building satellite connectivity on. I said, how do you know which ones are profitable? He said, I don't. I said, Well, there's our task for the week. So he spent a week and basically broke it out into 10 financials and figured out that he had three routes that had no customers on it.

[00:25:02.510] - Dan

Oh, wow.

[00:25:03.460] - Rich

I said, what are you paying for those for? And he said, for growth. I said, but you don't have the growth. So you've got three contracts you're laying out money for that you don't have pretty expensive revenues. You don't have any revenues coming in on them. So we canceled those three routes. And all of a sudden he went from three million dollars in revenue to $15 million in revenue because he was able to take that money and reinvest in routes that actually were already saturated, they were already full. So he expanded into those routes, went to the customers he couldn't supply, built that additional revenue stream. And ultimately, I'll just go to the end game, ultimately he got bought out by Panasonic. So he became big enough that he became a target for a global leader like Panasonic, and that's where the company went. So I knew them when they were a million dollar company, and they went all the way to the top route, and it came down to a decision on the financials.

[00:26:07.270] - Dan

I think that's what you're pointing out there is what most companies don't realize, because we also talk with a number of companies, both you and I, that are looking for that next phase in their growth or their development. And a lot of times that's succession. You got an owner that's in their 50s that's starting to think in the next 5-10 years that I want to either retire or sell the company. You ask them, Well, what do you think the company is worth? Which sometimes I think is the biggest mistake possible because they give you some exorbitant number. Oh, my company is worth $20 million. Then bring in the financial guy he looks at, now you're worth about five. That's only if you get out of your own damn way and let other people do stuff here, otherwise you're worth whatever the assets are worth. Right.

[00:26:56.950] - Rich

Yeah, that's 100% accurate because that's the other thing you brought up the initial example, what's on the balance sheet and what's on the PnL, those decisions make huge impacts on what your valuation is, because generally the valuation method is off of either, and I'll just use these terms, either earnings before interest taxes, depreciation and amortization, or off of free cash flow. It's calculated off the numbers in the financials, and they're generally pieces of the profit-law statement. But when you don't do the financials correctly or you put things on the balance sheet that don't belong or the other way around, you don't put them there and you should have, that affects your valuation. It affects what you can sell it for. If that's what your goal is to sell the company, do your financials right because you could go through the whole process and spend a lot of money on people doing your due diligence and doing the sale process for you. And at the end of the day, if the financials are wrong, your buyer will leave.

[00:28:04.900] - Dan

Yes.

[00:28:05.710] - Rich

They're really going to rely on your numbers. And if your numbers don't give them comfort, they're not sticking around.

[00:28:14.060] - Dan

Those numbers can't be right for just one year. You need multiple years showing consistency. Absolutely. Because I know there are people that'll say, let's face it, most small or privately held businesses, they're doing everything they can to minimize their tax burden and also maximize their own pocketbook or their own lifestyle. You see a lot of companies where profits have been drained out to the owner. They're still doing everything legitimate and they're still paying taxes on it. But they essentially try to get that business as unprofitable as possible to keep their tax burden low. Well, when you go to a sales situation, as you point out, they're looking at the financials. If it looks like you're not making any money, you're not going to get a premium dollar for selling that business. You're going to get some derivative thereof unless you can convince them that, no, there's really a lot more money in this business. It's just that you use different tools to do some tax sheltering and take that money out.

[00:29:15.910] - Rich

It comes into the same play. Even if you're not selling, it comes into play when you are trying to go to the bank because you want to buy another office down the street, another factory, a bigger warehouse, you want to do improvements. You go to the bank and say, Please give me X dollars. Well, the bank is going to do the exact same thing. They want your financials. They want to know, Well, how am I going to prove to myself that my debt committee, my lending committee, how am I going to teach them that you're good for it, that you're going to make this profit? And if your financials don't show it, there's no loan.

[00:29:54.880] - Dan

Exactly. I've seen a number of companies actually get caught in that trap because guess what? You're looking for the loan a lot of times when you need the money. And the first rule in banking is they don't lend money to people who need money. You got to be able to prove that you can pay that loan back. And if you seem like a high risk opportunity here, you're going to get turned out, or you are going to pay much higher interest rates and much less favorable terms.

[00:30:24.960] - Rich

Exactly. I've seen too many. Just like you said, I've seen too many where it's like, Oh, I need to get this done. And you have to be the person who says it's not going to happen. Situations also, you're trying to expand and you're trying or you're trying to, let's talk about a turnaround, where you have an investor who's willing to put money in at a certain valuation and turn around a company. But the minute you got to make sure they're well, you have to make sure that they are well comforted that these are the actual numbers. It is not pretty when you give them financials showing everything is rosy and then they're not rosy. They find out after they make the investment, that is a bad, bad situation. You do not want to be in that one.

[00:31:21.760] - Dan

That's where that due diligence becomes so critical. You need to go through and audit those books. I pulled up this article here, and I know you've seen it, but I thought there were some really good examples on here. We've talked about some of this. Not having a detailed business plan, probably less of an issue if you're an established company. But I will say this from the operations side, whether it's strategic planning or business planning, at some point, probably about every 3-5 years, you should review what your business plan is and make adjustments accordingly. Obviously, that's often called strategic planning for the most part. Companies sometimes do it. Companies sometimes do it as a checkbox item, but they really don't look at the whole of the business that they're doing. Because as you and I both know, I think both of our businesses have changed multiple times over the last however many years. I'm going on 20 years of doing what I'm doing, and what I did on day one is not what I'm doing today. I'm guessing you're the same.

[00:32:23.700] - Rich

I'm 100% the same. Yeah, what I was doing on day one is not anywhere near what I do now.

[00:32:30.970] - Dan

Exactly. Definitely looking at that business plan, the cash flow management, we beat on that quite a bit. Cash is king. If you want to grow, if you want to sustain, if you want to do whatever you want to do, it's all about the collateral. And the primary collateral that you're going to have is your ability to produce cash. Mixing personal and business finances. How many companies do you see do that? Somebody's got a nice yacht that was conveniently paid for by their business operations. And some of this is legit. You can do it. Don't get me wrong, but.

[00:33:12.100] - Rich

That's- Luckily, I haven't seen the yacht, but I did see the fishing boat.

[00:33:16.180] - Dan

Yeah, the fishing boat. I've seen lots of things. I've seen yachts. Some of them are legitimate, though some are actually good investments. So don't think that... The main thing is difference between business versus personal. If you're buying that new house and it's all for you and it's not for a business reason, but you're using business funds to do it, it's questionable there. That might even lead to some certain tax implication issues if the IRS comes knocking on your door. You want to be really careful with that. Overlooking tax obligations. Now, Rich, you might want to talk to more about that. What are some tax obligations that people maybe ignore or don't pay close enough attention to?

[00:34:04.790] - Rich

Well, I think the biggest one is where LLCs and sCORPs don't pay tax on their own. They push the income out to their owner. Right. I think that owners need to understand that. When they take the money out, most owners that I've worked with over the years seem to think that the IRS comes second, that I didn't make that money. A lot of times that's where the numbers come in, where you need to understand that the money that went in your pocket is not necessarily the money that the business earned. If the business earned more but hasn't collected it yet, you pay tax on it, even though you didn't collect it yet. It becomes a problem with some founders because they think, Well, we didn't collect it, so we don't owe taxes. The taxes gets pushed back to a secondary level of what we owe. Because of that too, LLCs that have pushed the earnings out, the owner has the liability for the taxes, not the business. The business doesn't show it anywhere that it owes taxes because it technically doesn't.

[00:35:25.620] - Dan

The owner does.

[00:35:26.840] - Rich

It becomes a bit of the unrecognized tax has become a problem because they can become a liability that can be on your personal. It can start attacking you personally.

[00:35:48.740] - Dan

Right.

[00:35:49.860] - Rich

It really becomes important that you recognize it, pay it, stay ahead of it, because if it builds too fast, it'll get away from you, and then eventually you wind up with a judgmenton your personal tax, on your personal credit score. That'll stop you from getting financing anywhere, not just for you, but probably for the business too.

[00:36:08.320] - Dan

Oh, yeah. Because the government is always the first in line.

[00:36:12.140] - Rich

Yeah. You can't go bankrupt because the government will say, Well, those are taxes. I think there's definitely limits there on what you can say. Bankruptcy doesn't necessarily wipe off taxes.

[00:36:27.090] - Dan

Right. Yeah, definitely. We talked about poor pricing strategies. I think that's critical, especially small to medium size companies that don't believe they can charge more. They run the risk of actually not charging enough and charging themselves out of business. Ignoring financial statements. Not only do people not look at them, sometimes they actively don't look at them, right?

[00:36:53.240] - Speaker 2

Yeah. Thanks for the report. Here it is. It's in my folder.

[00:36:57.430] - Dan

I know it's bad. I'm not going to check it out because that just affirms what my beliefs are. Hey, failing to plan for emergencies. I think we did a podcast on that one.

[00:37:09.380] - Rich

Yeah, we did.

[00:37:10.630] - Dan

Yep, over reliance on a single revenue stream. And this is a common thing too. It falls back to that 80-20 rule. 80% of your revenue comes from 20% of your business. Well, that's bad enough, but what if it comes from one or two? I've heard situations where I was talking with one company, the one manufacturing company at one point, one business, one client basically was 90% of their revenue. What happens if that client goes belly up? What happens if they decide they find another vendor, they don't want to work with you anymore? You're basically shuttering your doors, unless you figure out a way to diversify that one money trough that you're dipping into. It gets a little scary whenever I see a situation where there's one or two clients that are pretty much paying everything, especially when it's a highly profitable business and it's all coming from that one resource. It can kill them in a heartbeat.

[00:38:13.770] - Rich

Those concentrations are a big factor. And if your company is not audited and you suddenly need to get audited, prepare for those conversations because the auditors will automatically ask you about concentrations not only in revenue stream, but in receivables.

[00:38:34.650] - Rich

In.

[00:38:34.990] - Rich

Payables, and suppliers, customers, lending activities, are you all in with one set of people?

[00:38:52.340] - Dan

Yeah.

[00:38:52.760] - Rich

So the story I told at one point about in one of our podcasts about the company that shuttered their Chinese factory and went to the Dominican Republic, that's a big concentration issue. It became a recurring question every year of who's supplying your product and how are we comfortable that they're not going to close their doors and then you can't get product.

[00:39:17.500] - Dan

Yeah. Then carry that over to, let's say you're planning on selling your business, you're looking for a buyer. If they look at concentration and say, Well, all your business is with that one client. What if I buy your company and that client decides they don't want to do business with me anymore because I'm not you? Oops. There's that issue too. You really need to look for ways to diversify your finances that way too if you're planning on selling.

[00:39:44.370] - Rich

Yeah. It can come in a number of forms. I mean, I can come up with 100 different examples of why people ask the question. I had an oil and gas support company that was providing to 16 oil and gas rigs. When they went bankrupt, all of those contracts had clauses in them for, if you go bankrupt, we can cancel the contract. So not only did they go bankrupt, but 14 of the 16 contracts canceled.

[00:40:23.720] - Rich

So.

[00:40:24.560] - Rich

There is no real bankruptcy plan out of that because there's no more revenue to protect.

[00:40:29.900] - Rich

Right.

[00:40:30.400] - Rich

So one of the reasons that they could not find a buyer to help them out and buy them into solvency.

[00:40:40.220] - Rich

Everybody.

[00:40:40.880] - Rich

Saw that contract. Everybody saw that clause in the contract. So that concentration became their real downfall. They were in trouble and they knew it and they tried to come out with it, but that clause in the contract put them unbuyable and took them out of contender, took them out of contention.

[00:40:59.160] - Dan

Businesses want certainty. The moment you create uncertainty, it's like rats from a ship. They will be gone as quick as they can. The last one on here is neglecting plan for growth. We talked about that one too. You've got to put in place that strategic plan. You got to look at where your growth is happening. You got to look at where your concentrations are, and you got to make efforts to make changes so you can support the future business growth.

[00:41:24.220] - Rich

Add one more concentration. If you're the owner and everything has to go through you, there's concentration.

[00:41:30.710] - Dan

That's my favorite one. That's usually what gets me plenty of business. I can't do this all anymore. Well, it started with you, so now we got to extract you from your own damn company. Yeah, definitely a good point there because so many owners, small to medium size companies, especially where the owner started the business, grew the business, and now they control everything. And you have employees, but your employees can't make a move or do anything without your approval. It's a little scary.

[00:42:05.650] - Rich

Totally agreed.

[00:42:08.200] - Dan

What else can you tell me about finances? Rich, we've only been talking for a little bit here. We're approaching that half hour mark, so we'll wrap up here pretty soon. But is there any other key points that a business owner should be watching for when it comes to their P&Ls, their balance sheets, their cash flow?

[00:42:26.290] - Rich

I think we hit on a lot of the big ones. I think the other one that I think is a, I'll give you a little bit of a free lesson. When people start talking about, I need a new piece of equipment. Should I lease it or should I buy it? I always look at who the business is and not so much the numbers because everybody wants to tell me what if I lease it, it's going to cost me $300. If I buy it, it's going to cost me $400 or $200. It doesn't matter, whatever the numbers come out to be. But I always ask people, What's your ultimate goal? The reason I ask that is we talked before about how the financials impact your valuation.

[00:43:18.420] - Rich

There's.

[00:43:19.010] - Rich

Nothing in the financial statements about valuation. Valuation is done using the foundation of the financial statements, and then they build the calculation off of that. The difference or the key difference between whether you put something on the balance sheet and depreciate it versus whether you lease it. Nine times out of 10, if you lease a piece of equipment, it goes into operating expenses, which is above that earnings before interest taxes, depreciation, and amortization. That's where the valuation starts. You've just lowered your starting point for your valuation because you lease that piece of equipment.

[00:43:59.300] - Dan

To be clear on the difference between leasing versus buying, I know it might seem obvious to some people, but the reason it's on the expense sheet is because it's not an asset anymore. It's just like paying rent on an apartment. If you don't own the building, you're paying rent. If you quit paying rent, you're out of the building and that's it.

[00:44:18.600] - Rich

The thing is, if you bought it, it's yours. It's titled to you. You put it on your balance sheet as an asset. Then yes, you depreciate it over time. But think about what I said before. The valuation starts at earnings before interest, taxes, depreciation, and amortization. The effect on your financials and on your valuation is zero if you buy it. If you're in the mode of I got to build this business up to sell it, I would almost automatically tell you you need to buy the asset if you can't. Because leasing might have a lower price, but it has a direct effect on the valuation of your company. If you're trying to sell and you go and lease that equipment, you've decreased your value.

[00:45:06.160] - Dan

Yes. Now at the same time, leasing might be good on a short term scenario where maybe you don't have the cash flow or maybe again based on the technology, you don't need to keep that asset for a long period of time because it might be more costly to keep it due to technology changes than it would be to just lease it and have it go away. I think of like copiers, for example. I don't know of too many people who buy their copiers. They tend to lease them from a third party and then keep them for a couple of years, and then they bring another one in and the process starts all over again.

[00:45:41.490] - Rich

Agreed.

[00:45:44.310] - Dan

Well, I think we've pretty much covered it. We covered a lot of different things. So go with your take, Rich. What's your take away from what we've talked about today?

[00:45:55.780] - Rich

Oh, the biggest one and probably the most important one and the one that I'll probably be screaming from the rooftops is get your financials monthly and review them. Make sure you actually go through and understand them if you don't ask because it's so important and it makes such a difference in what your decision making is. The flying by the seat of your pants thing is just not sustainable. In today's day and age, get your financials and actually review them.

[00:46:32.900] - Dan

That's a great point. I will add on that, but I will also link it to what we're doing here. To me, this is just another example of how important it is to understand the marriage between your financials and your operations. What you do financially affects your operations and vice versa. If you don't have a link or an understanding or your people aren't communicating in those two areas effectively, it is going directly impact the success and the profitability of your company. So that's where if you don't have it internally, you need to find it externally. And I'll tell you where to start. Here's where I would start. I would contact Rich Valtry. Rich, where can they get a hold of you at?

[00:47:14.800] - Rich

The best way to reach me is my email address at rveltre@veltregroup.com.

[00:47:21.170] - Dan

And you can always get a hold of me at danpaulsonlet'sgo.com. If you want to see any of our other wonderful podcasts, I believe these are getting better and better each time we do them. You can check us out at booksnbiz.com. That is books, B-O-K-S-N, the letter N, and biz, B-I-Z, so booksnbiz.com. You can also find us on YouTube. If you want to see our beautiful faces, you can definitely check us out there. Definitely be sure to like, subscribe, hit notifications, do whatever you need to do so you get these podcasts in the future. And we look forward to seeing you next time around. Down. Rich, thanks again for all your wonderful financial insight. I'm sure we could have gone on for two or three more days about this, but we both got to eat at some point and I think we got to do business as well. We'll wrap it up here and we will see you next week.

[00:48:14.550] - Rich

Sounds good, Dan. Talk to you later.

[00:48:16.600] - Dan

Thanks. Take care.