Published April 2002

Managers, it’s time to get grip on financials

All things considered, this might be a good time for managers to take a hard look at what we know, and what we don’t know, about accounting. It seems that the long, scaly arm of Enron is going to touch us one way or another.

Some business owners and managers have both academic training and professional accounting experience. Few entrepreneurs and managers, though, are well prepared to wrestle with accounting issues, and many are uncomfortable with financial reports. They pay little attention to that side of the business beyond “the bottom line” and are content to leave accounting and financial reporting to others.

That approach is quickly becoming a luxury few of us can afford. There is a post-Enron heightened awareness of how carelessly prepared or deliberately misstated financial reports can distort the reality of a business.

And even if we were blissfully unaware of Enron and how it has stunk up the room for American business, the government is busy preparing new regulations that will make us all more responsible for our financials. (In most cases, we already are responsible for them, but most times, the regulations are enforced only when out-and-out fraud is involved.)

Except for the likelihood that regulators will go overboard to “make an example” of some CEO, there really isn’t any bad news in all this. The truth is, if we want to be good managers, we need to know some of this accounting stuff anyway. The enemy is time. Few of us have the luxury of dropping everything to return to school as accounting majors.

Fortunately, this is one of those times where the Pareto Principle — “The 80-20 Rule” — works in our favor. The Pareto Principle instructs us that 80 percent of the things that go wrong are caused by just 20 percent of the possible problems. And most of the accounting-related things that go wrong in a company can be traced to just a few basic areas.

One accounting area that is so often a source of problems is the “cost of goods sold.” Its structure is very much like a checking account, and is not really much more complicated. You start off with what you have on hand at the beginning of the month (beginning inventory) and add your purchases, and that’s what you would have if sales were zero. Subtract what you actually have left at the end of the month, and the number that’s left is your cost of goods sold. Your cost of goods sold is the inventory that went out the door.

Depending on the company, the calculation of the cost of goods sold can become complicated when various labor, shipping and other expenses become part of the inventory cost. For managers, though, the important part is still the simple part: The cost of goods sold represents inventory that went out the door, and it should be a fairly stable percentage of your sales revenue. If it isn’t, you need to find out why.

Another area that is often the source of accounting issues is “revenue from sales.” You would think that nothing could be simpler, but lots of businesses have gotten into trouble by counting income incorrectly.

Ideally, you would not count anything as a sale until it went out the door accompanied by an invoice to the customer. For some businesses, though, it isn’t as simple as that. Even the smallest construction company has to deal with questions of how to match up revenue and expenses in any given time period when all or part of the payment is delayed until project completion.

The important thing for managers is consistency — always recognizing income the same way. Surprisingly, the federal government, in the form of the IRS, can be of some help to you. Defining income is their business, and they have put together all kinds of accounting instructions for various kinds of business. And these instructions are often easier to understand than the accounting textbooks on the same subject.

Understanding accounting can sometimes be demanding, but it is important for us ordinary mortals to remember that it isn’t rocket science. Most business owners are more than smart enough to understand what they need to know, and to be suspicious of those things that are too complicated to explain. If there is a positive legacy of Enron for managers, it will turn out to be this: If you can’t understand it, you probably shouldn’t be doing it.

James McCusker, a Bothell economist, educator and small-business consultant, writes “Your Business” in The Herald each Sunday. He can be reached by sending e-mail to otisrep@aol.com.

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