The Price of Bad Bookkeeping & Why I Finally Decided to Make a Budget : The Benefit of QuickBooks

Ami Kassar for the New York Times writes: I recently had to place a small-business owner in a 27-percent annual-percentage rate cash-advance loan. The sad thing about his situation is that he might well have been eligible for a six-percent bank loan. What stood in his way was that he was six months behind in his bookkeeping, and it would take weeks for him to get his books in order.

Unfortunately, he needed the money right away. And there isn’t a reasonably priced lender out there who will lend to anyone with such outdated financials. It’s easy to look at this situation and think that this owner got what he deserved. But the reality is that it’s easy to slip on keeping up the books. I am guilty of it sometimes, too. When I get lazy, I keep an eye on the bank statement to make sure cash is coming out, and I save the bookkeeping for later.

I was reflecting on this recently, as I watched my 12-year-old son play basketball. While I confess to not understanding much about the game, I love the intensity and I love watching how he has grown and changed as a player over the years. And I see similarities between being a basketball player and an entrepreneur.

Perhaps most striking is how quickly you have to flip between playing offense and playing defense. At any moment, everything can change. In basketball, you wouldn’t try to get on the court if your shoes were untied. And in business, you really can’t play the game unless you have a core understanding of your financials and cash flow. Unfortunately, many small-business owners are so focused on their trade that they don’t give sufficient time or attention to their books.

And then the unexpected happens. Suddenly, you are playing defense, and you need those financial statements. If you are unprepared, it’s as bad as being on the basketball court with untied shoes. Every day, at my loan brokerage, we get phone calls from business owners who are dealing with something new and want to look to a loan for help. The state of their financial statements will often dictate what options are available and what rate they will have to pay.

It’s easy to pin the blame for the lack of access to credit on unreasonable bankers. And while I believe the banks share responsibility for the chaos of the last few years, some of that responsibility falls on the shoulders of entrepreneurs as well. Would you lend your own money to a business that had no real sense of where it stood financially? I certainly would not.

The issue of outdated bookkeeping is particularly important at this time of year, when we see many clients who are in the process of compiling their receipts and bank statements for the previous year so their accountants can prepare their tax returns. I recently met with an accountant, Andrew Berg, whose practice is small-business focused and who demands accountability from his clients.

“We require all clients to either have a good internal set of books or allow us to spend the time to get them clean,” Mr. Berg said. “We would not be willing to continue a relationship where the books aren’t progressing toward being clean. The only way to know for sure how the business is doing, and properly advise the client, is to have clean records with accurate information.”

A year ago, I hired a service to do a monthly reconciliation of my QuickBooks Online account. It’s not perfect, but I knew it would at least provide a check against my own chaotic, entrepreneurial mind.

How do you manage your books? How do you ensure that they are reasonably up to date and in-order? Have you paid a price when they were not?

Why I Finally Decided to Make a Budget

Paul Downs for the New York Times writes: I read Ami Kassar’s recent post on sloppy bookkeeping with interest because I spent so many years struggling to figure out why I was always running out of money.

I do have an excuse: I started my business a long time ago, in 1986, and many of the business tools we take for granted didn’t exist, or at least weren’t accessible to a tiny company like mine. Obviously, I had no Internet, e-mail, cellphone or Web site. It may be hard to imagine, but personal computers were just getting started, spreadsheets were primitive, and QuickBooks was years in the future. So I got off on the wrong foot, and it took me a long time to recover.

Fast forward 26 years, and I have put in place a reasonable set of accounting tools and learned to do a little spreadsheet writing. I now do my bookkeeping and accounting with QuickBooks. I calculate my pricing for custom work with Excel. And I track cash flow using Google spreadsheets. With these, I can do all of the standard accounting tricks, which mainly look backward in time at what happened to my money, and even look a little into the future to predict short-term cash flows. Until last week, though, I had never created a budget for the coming year.

I have found it to be much easier, using QuickBooks, to look backward rather than forward. Maybe this is because accounting is geared toward actual transactions and is less equipped to handle the future. Maybe it is because the conventions of accounting date back hundreds of years and just haven’t been updated to take into account the ubiquitous spreadsheet, which allows for easy modeling of future cash flows. Or maybe it is because I’m simply uneducated with regard to the accounting software I use and can’t figure out how to make QuickBooks do my bidding.

If you don’t find those excuses to be convincing, and you shouldn’t, here is a better one: I was very, very busy with selling until recently, when I handed off that responsibility to my employees. Suddenly, I find myself with time to think about things, and I’m doing projects that I should have done years ago. One of them was to try to figure out whether I would be able to afford to pay myself a decent salary this year and also hire a couple of workers. So I decided to do a budget for 2013.

I had just run a profit-and-loss report out of QuickBooks, comparing 2011 and 2012, to see how much I was spending on materials and whether there had been any surprise expenditures. It was interesting to consider the entire chart of accounts, which for my small factory has more than 100 main accounts and subaccounts. It occurred to me that it would be simple to export the current P.&L.report as an Excel sheet and use the existing chart of accounts as budget line items for the following year. That way, I would not forget to include obscure yet expensive expenditures like leasehold improvement depreciation. With two years’ spending in each category, it would give me a good start toward figuring out reasonable amounts to budget for the coming year. And I could, with a little effort, convert some of the cells from straight numbers to formulas that varied with income, so that I could model alternative situations.

I’m not a spreadsheet genius, but I have learned enough to accomplish my goals: how to write simple formulas and how to make a cell in one sheet refer to a result in another. With that level of mastery, I was able to set up the budget so that the material spending varied as a percentage of revenue, with the baselines determined by averaging the previous two years. I was also able to assemble a separate sheet that had a complete model of my employee labor costs, including pay rates; forecasts of hours of regular time and overtime for each worker; the federal, state, and unemployment taxes that their wages would generate; and their retirement plan contributions.

Because this is so complicated, I have made a copy of the original — with the numbers scrambled a bit for the sake of my privacy — and posted it here. It’s a Google Doc and shows only the values of the cells, not the formulas, so I added some comments to clarify the relationship between the budget and labor sheets. Also, the chart of accounts is ours, and your results may vary. I don’t expect anyone to copy this exactly, but it will give you an idea of one way to set up a budget and make it into a forecasting model.

When I finished my budget using my real projections — including a rise in revenue to $2.4 million, a reasonable salary for myself, what I expected to pay all of my people, and expenditures for materials proportional to the rise in revenue rise — I found that I would have only $54,000 left over. That is pretty slim pickings out of $2.4 million. It wouldn’t take much of a revenue shortfall or unexpected expense to wipe it out entirely.

Of course, I could make that number jump by cutting employee salaries, or my own salary. I did budget $73,500 for some projects I expected to complete: a second Web site and some computer and machinery purchases. But I could choose not to spend that money and improve my bottom line. The most promising source of savings, though, is materials. I’ll be taking a hard look at some of those expenditures to see whether we cannot buy more efficiently.

After doing all of this, I went back to QuickBooks to take a look at the built-in budgeting tool. There is one there, but I found it disappointing. (Here is a reasonably succinct explanation of how to use it.) What it does not do is let you import the previous year’s actual spending to use as a starting point, and it also does not seem to allow you to enter formulas to make different accounts dependent on each other, which is why I much prefer using a spreadsheet. I wish that there were a simple and painless way to set a budget, but — as with so much of the financial side of running a business — there are not any shortcuts.

Getting back to Ami’s post, it covered all of the reasons to keep your books up to date. And I have nothing to add — except to say that once I started putting in the time every week to see where my money was going, I suddenly had more of it. Not always as much as I wanted, but enough to build up a decent amount of working capital over the last three years. Now, with my budget in hand, I hope to do even better in 2013.

Is Financial Planning Being Commoditized? As Services Get Automated, Planners Will Have to Go Deeper

I was reading an interesting comment in the Wall St. Journal wherein it was said, "Online financial planning probably won't damage person-to-person financial planning the way Turbotax has taken a bite out of brick-and-mortar tax preparation, says Nerd's Eye View. Tax scenarios are a lot less nuanced than financial-planning issues, and so easier to automate. But other services provided by planners -- passive-fund investing, performance reporting -- are easy to get online, and getting better by the day. This will put pressure on advisers to come up with plans that fit with each client's circumstances, says the blog".   Interesting, so let's take a look at Nerd's Eye View vision of where Financial Planning is heading.

Is Financial Planning Becoming Commoditized?

As we enter the digital age, technology has been a driving force in putting pressure on many industries, taking any goods or services that could possibly be commoditized and driving their profit margins down to a sliver. In recent years, many have wondered whether financial planning may soon be impacted in a similar manner, especially given how software like TurboTax decimated the profitability of tax preparation services. After all, the commoditization has arguably already begun for some parts of the financial services industry, as costs have plummeted for trade execution and index investing and many software packages offer the ability to perform relatively sophisticated financial planning projections entirely for free.

Yet the reality is that financial planning itself may remain remarkably resistant to commoditization for the foreseeable future, for the simple reason that financial planning is incredibly customized and unique to the needs and complex circumstances of the client, and outcomes can still vary greatly depending on the expertise and the skillset of the planner (unlike tax preparation, where ultimately the outcomes are exactly the same because all clients and their preparers both have to follow the same IRS guidelines). In fact, arguably the greatest challenge in financial planning is not that services are so nearly identical from one planning firm to the next that the only competitive factor is price (as occurs in commoditized markets), but instead that the planning experience is still so different amongst firms that consumers struggle to determine which planner would be the best fit in the first place!

Nonetheless, the caveat is that for advisors who have linked the profitability and success of their businesses to a commoditized service, such as charging a fee just to gather data and do financial planning software projections, or charge an assets-under-management fee just to provide strategic passive asset allocation using index funds, the pressure is on to step up and deliver a greater value. Ironically, in the end that means not only is financial planning not being commoditized in a manner that makes financial planners irrelevant, but the reality may be that it's about to get even more competitive with more financial planners than ever, as an increasing number of advisors realize the components of what they provide have become commoditized and that they must step up to provide a deeper, higher quality of financial planning advice and services for their businesses to survive and thrive! 

---

What Does It Mean To Be Commoditized?

Although it's a term that's often thrown around lightly, the true process of "commoditization" occurs when a particular series of goods become indistinguishable and undifferentiated from one another, such that they are viewed as being perfectly interchangeable with one another. By contrast, goods that have not been commoditized may have several points of distinction, from particular features and benefits to even more ephemeral qualities like brand. This is important because differentiation not only allows businesses to compete based on these qualities, rather than price alone, but also because it allows for a richer and more varied marketplace where there can be multiple companies that survive and thrive, each with their own particular version of the product and each with their own target audience of consumers who buy it.

By contrast, when goods are viewed as entirely undifferentiated and interchangeable, the only way to survive is to compete on price by trying to be less expensive than the competition... if possible. In practice, this can quickly topple businesses, as not every company can drive down its costs of production to provide the good on a cheaper and cheaper basis to undercut the competition. Only the cheapest producer survives in a fully commoditized marketplace. As a result, most goods and services are not completely commoditized, in large part because the businesses that provide them try hard to avoid this outcome, maintaining differentiation by any means possible.

Nonetheless, a great deal of commoditization does exist in many industries. For instance, many types of technology goods have been commoditized; while computer processors may remain competitive because of various processing speeds, more "mundane" parts like keyboards or power supplies or hard drives are often viewed as undifferentiated and interchangeable, where it's easiest to just purchase the cheapest solution. This is similarly true for many other products as well, from auto parts to construction materials to cleaning supplies. And of course, the term is commonly used for a number of financial markets goods that are similarly viewed as interchangeable "commodities" such as gold, silver, orange juice, cocoa beans, heating oil, and more. Notably, the concept of commoditization can apply in the service industries as well; for instance, internet and cable service has been largely commoditized (although the companies try to differentiate themselves with offerings like premium channels), and commoditization has also struck much of the airline industry, and even annual services like tax preparation.

What Is Being Commoditized In Financial Services?

In the broad financial services industry, many parts of the business have become largely commoditized in recent years, as evidenced by the strong downward pressure on prices for certain services. On the plus side, this allows consumers to get many services cheaper than ever; the downside, however, is that it's a very dangerous environment for companies that risk being made irrelevant if they cannot find a way to cut their own prices enough to compete.

For instance, the execution of investment trades has become almost entirely commoditized over the past two decades, driven heavily by the automation of technology and the rise of online brokers like Charles Schwab and E-Trade; as a result, executing a stock trade a few decades ago might have required the services of a bona fide stockbroker and cost $100-$200 or more, while in today's marketplace if can be done using digital tools for no more than 5% - 10% of that cost from a few decades ago... and in some cases, less, or even entirely free!  Similarly, the world of indexing has also been largely commoditized in recent years, a trend that began with Vanguard but has accelerated with the rise of Exchange-Traded Funds (ETFs). As a result, the investment expenses that must be undertaken to gain raw exposure to the markets just continue to fall lower and lower, as consumers simply buy whatever commoditized indexing vehicle is available at the lowest cost - since, by definition, the actual investments in the index would/should be identical. 

Of course, the forces of commoditization have been playing out in other industries related to financial services as well. For instance, the rise of companies like TurboTax and H&R Block have drastically cut the pricing for tax return preparation (which posed a significant challenge to many established accounting firms); arguably, though, tax preparation was especially prone to commoditization risk, since the process is dictated by adhered to IRS rules and therefore everyone should ultimately end out with the same tax return results. Similarly, the rise of online services like LegalZoom has begun to put pressure on the cost for basic legal documents of all sorts, which again are typically identical or substantially similar for at least the majority of consumers (until the needs and situation become more complex for a select few).

Is Financial Planning Being Commoditized?

So given this context for what it means to be commoditized and the trends in the overall financial services industry, what is the outlook for financial planning in particular?  Overall, it's difficult to see how financial planning itself is in any danger of being commoditized in the foreseeable future. The primary reason is simply that the nature of customized, personalized and comprehensive financial advice is itself not conducive to being commoditized; to the extent every client's situation is different, and the circumstances for applying advice vary too, it's difficult for commoditization to take hold (although arguably planning firms still have a lot of room for more standardization of process and deliverables). This is quite different than a service like tax preparation, where TurboTax was able to gain momentum both because everyone must go through the process annually, and because ultimately everyone must follow and implement the exact same rules. With financial planning, though, the client needs, services rendered, expertise of the planner provider, and tools for implementation, are all so unique from one client-financial planner interaction to the next, the reality is that getting financial planning services in today's marketplace is actually the antithesis of undifferentiated and interchangeable! In fact, ironically the greater challenge for financial planning may be that the services provided vary so much from one firm to the next that consumers have difficulty identifying a good planner in the first place or knowing what factors to prioritize when making a choice; to say the least, this isn't a marketplace where the only difference from one planner to the next is the price for an identical service and outcome! 

Notwithstanding the fact that financial planning itself isn't being commoditized, though, it's important to realize that many other services provided by financial planners or as a part of the financial planning process most definitely are becoming commoditized. For instance, as noted earlier, the execution of trading to the implementation of index portfolios is becoming rapidly commoditized; while few advisors still provide basic stockbroker execution services, this still puts a great deal of pressure on those advisors who provide little more than the implementation of passive, strategic portfolios, which can now be done for almost nothing from a wide range of online providers at an ultra low cost. Similarly, providing basic financial planning projections for retirement or other goals, accounting for a client's net worth and cash flow, or providing information on performance reporting, is also under commoditization pressure from a wide range of online computer- or tablet-based tools that are providing such information at little charge or entirely for free, from the RetireLogix financial planning "app" to the services of Mint.com to the more in-depth reporting options becoming available thanks to a wide range of "account aggregation" tools available for consumers. The end result - to say the least, there's no longer very much value in just gathering information and being able to report it back to clients the way that perhaps there once was.

Nonetheless, this doesn't mean that financial planning itself - the integration of these various points of financial data, client needs and goals, planner wisdom and advice, and subsequent implementation - are being commoditized, even though technology is certainly impacting many of the component parts. To the contrary, the opportunity is that as technology permeates the financial planning world, it will improve the planning experience and augment planners, not replace them, especially since ultimately the value of financial planning is about changing a client's behavior, and as human beings we simply don't feel accountable to change from a computerized commoditized service the way we do to another human being. On the other hand, the pressure is on for those who are masquerading as financial advisors without really providing valuable financial planning advice. If the goal is to get paid for just gathering a client's financial information, providing financial planning projections, executing investments and implementing passive portfolios, etc., the threat of robo-advisors is real, and business will not be sustainable as commoditization decreases the profitability of those services down to nothing. 

Yet ironically, in the end the reality is that as we enter the digital age, financial planning is not only notbeing commoditized in a manner that would make financial planners irrelevant, but the reality may be that it's about to get even more competitive with more financial planners than ever, as an increasing number of advisors realize they must step up to provide a deeper, higher quality of financial planning advice and services for their businesses to survive and thrive.