Anyone who has led a high-growth company will tell you that managing organizational growth is fairly similar to managing a teenager during the worst stages of adolescence.
It’s exhilarating of course, but more often than not it will challenge you at every juncture as you try your best to guide your company to success through what can seem like a field of landmines.
And much like a teen can get out ahead of him or herself when those growing pains hit, a company’s growth often gets ahead of the very people responsible for keeping your company safe and growth-ready: your financial team.
Fortunately, for CEOs and other leaders, there are just as many warning signs that your growing company might be getting ahead of your team as parents have when keeping tabs on their teen.
But before we look at those signs, let’s bust through a couple of misconceptions that can prevent you from getting a full and clear picture of how well your organization is doing in terms of profitability:
Misconception #1: You can look to the cash balance in your company bank account to determine profitability. FALSE, and here’s why: Cash balances are impacted by a number of factors, including whether or not you’ve paid vendors who have performed services yet and whether or not you’ve billed a customer for services provided. Either way, it may look like your company has more cash or less cash than it actually does. Inventory can also blurry the picture. If you purchase materials, for example, it’s certainly a cost. However, it’s an asset not an expense. So while cash can be a sign of profitability, it’s simply not a reliable way to measure it.
Misconception #2: Tax-based profit is a good measurement of profitability. FALSE, and here’s why: In some cases, and especially for smaller companies, taxes are prepared using cash basis accounting which does not take into consideration revenue earned but not yet received and expenses incurred but yet to be paid. In order to know how profitable your company is, you must use accrual basis accounting where revenue and expenses are recorded as they are incurred, and whether or not the money has actually been paid to your company or the expenses actually deducted from the bank.
Now that we’ve covered the two big misconceptions about profitability that can arise thanks to cash-based financials, I can say with confidence that having more cash in the company bank account is a GOOD thing.
As long as your company is sending out bills and paying vendors and employees consistently, an ever-increasing cash balance is generally a positive sign that profitability may be on the rise.
To be even more accurate in your assessment, though, examine trends over time and across multiple key ratios (including working capital, profitability and liquidity) rather than making a judgment from a single snapshot.
Changes in key ratios can also be an indication of underlying problems – which brings us right back to figuring out if your company’s growth is getting out ahead of your financial team.
Essentially, having a good understanding of your company’s true profitability requires solid underlying financial processes.
For public companies, solid financial processes might be considered a given since financials are audited and internal controls are tested for reliability through that process. However, we know that this isn’t always the case since public companies do have restatements and other issues after filing. These scenarios are typically followed by much publicity, SEC probes and class action lawsuits. So public companies can’t afford to rest on the laurels of their reported financials – and neither can private companies, perhaps even more so since those same controls are not in place.
For public and private companies alike, following are a few early indicators that should bring your firm’s profitability into question and trigger you to look under the hood of your company’s financials to see if they’re telling an accurate story about your business.
Early Indicators that Growth May Be Getting Ahead of Your Financial Team
Financials are Always Late: If you’re not consistently receiving financials on time, I highly suggest getting a second opinion on the processes that are enabling this to happen. As a rule of thumb, we like our clients to see monthly financials no later than the 15th of the next month.
Financial Surprises have become Normal: If you consistently run into financial surprises or restatements because items were missed, it’s a sign that the monthly process is not tight enough to capture the additional activity.
Major Accounts are Left Un-Reconciled: Cash accounts that are un-reconciled are big, fat red flags. These should always be promptly reconciled at the close of the month.
Customer Invoices are Tardy: If customer invoices are not going out on time, it’s a sign of a possible process breakdown – one that could result in a cash crunch down the road (and not very far down it).
Financial Team Members are Out the Door: Above average turnover in the accounting department is a serious sign that something is wrong. People tend to want to stay when they’re part of a high-functioning team or department, and flee when systems and processes are mess. Turnover could be an indication of burnout, if resources are spread too thin. If people are leaving your financial team in higher than normal numbers or frequency it can also signal a much bigger problem related to transparency, integrity, honestly and plain old ethics. But whether it’s better processes or a lack of resources needed to do the work, or a complete investigation aimed at rooting out bad players, there is no doubt that above average turnover on your financial team deserves your attention.
Growing companies can exhibit the above warning signs because of the strain growth puts on all operations. However, growth can never be an excuse for letting important financial activities fall through cracks.
You and the other leaders in your company should be on the lookout for any signs that your financial function may be in trouble (whether your company is in growth mode or not) and be ready to take immediate action to shore up processes and systems, as well as make personnel changes, before they impact profitability.
Of course, developing a strong financial function involves a highly specialized skill set, so taking action may mean bringing in outside guidance to audit the department, coach employees into new and bigger roles or help you conduct a complete overhaul of processes and people. Given that it’s quite literally your company’s bottom line that’s at stake, any investment you make to ensure your financial team keeps pace with growth is an investment that will pay back in spades.