Summary
In this episode of the Ecommerce Finance Podcast, Stephen Brown and Geoff Gualano discuss the critical role of accounting in ecommerce businesses. They explore the different phases of accounting maturity, from initial awareness to strategic forecasting and planning, emphasizing the importance of accurate accounting for business growth, investment opportunities, and overall financial health.The conversation highlights how understanding and implementing proper accounting practices can significantly impact a brand’s success or failure in the competitive ecommerce landscape.
Takeaways
- Accounting can significantly impact the success of a brand.
- Many businesses start with no accounting practices in place.
- Phase one is about recognizing the necessity of accounting for taxes.
- Phase two focuses on gaining visibility into business performance.
- Accrual accounting is essential for ecommerce businesses.
- Understanding accounting can prevent cash flow issues.
- Phase three involves strategic forecasting based on historical data.
- In Phase four, investors and lenders require accurate financial statements.
- Proper accounting practices can enhance business valuation during acquisitions.
- AI may assist in accounting but won’t replace the need for human oversight.
What We Cover:
00:00 The Importance of Accounting in Ecommerce
01:49 Understanding Accounting Maturity Phases
03:15 Phase One: The Awakening to Accounting
06:24 Phase Two: Gaining Visibility into Business Performance
11:39 Phase Three: The Transition to Strategic Accounting
15:53 The Role of Accrual Accounting in E-Commerce
21:18 Understanding Revenue Recognition Challenges
23:13 The Importance of Accurate Financial Visibility
25:18 Strategic Financial Planning and Forecasting
28:31 Building Trust with Accurate Financials
30:35 The Consequences of Poor Inventory Accounting
33:25 The Four Phases of Accounting Maturity
36:16 The Role of AI in Accounting Accuracy
Work with LedgerGurus
If you need help with your ecommerce accounting, reach out to us at LedgerGurus. We are an ecommerce-specialized accounting firm, and we handle all your numbers so you can focus on growing your business.
Transcript
Stephen Brown (00:00)
Welcome to the ecommerce Finance Podcast. I’m your host, Stephen Brown, COO at LedgerGurus. In this episode, I have Geoff Gualano from A2X here to discuss why accounting can make or break your brand. Today’s episode is brought to you by LedgerGurus, your go-to team for ecommerce accounting. We’ve built up some of the deepest capabilities to support businesses selling online. Head over to ledgergurus.com and see how we can help you level up your business today. That’s L-E-D-G-E-R-G-U-R-U-S.com.
Alright, Geoff, welcome to the podcast. Tell us a little bit about yourself.
Geoffrey From A2X (00:34)
Thanks for having me, Stephen. So I’m Geoff. I’m the head of marketing at A2X, ecommerce accounting automation app that helps automate payout reconciliation from Amazon, Shopify, and all your other sales channels. I love marketing. I’ve been a tech marketer for just about a decade now and specifically in the cloud accounting space, probably for the last seven years.
So most recently with A2X for the last three years and then previously to that, head of marketing at Hubdoc and then eventually acquired by Xero where I led product marketing for its core accounting products. I’ve been in this space for quite some time. I can see the value of accounting and I’ve quite literally seen it make or break businesses in ecommerce but in multiple other industries over the years. So happy to dive into this topic with you, Stephen.
Stephen Brown (01:23)
Yeah, well, we’re going to talk about, you you could apply to a variety of industries, but we’re going to specifically discuss how it applies to ecommerce with our collective experiences. So if you’re a brand listening, don’t hang up. This is for you as well. Yeah, good luck. I’ve been trying to do that for eight years and it’s still boring, but it’s useful.
Geoffrey From A2X (01:38)
We’re gonna make accounting fun.
Stephen Brown (01:49)
All right. We had this concept we were talking about when we wanted to, when we were brainstorming about this episode around how businesses go through different levels of accounting maturity or maybe accounting and finance maturity, how, they view accounting and finance. And each one’s important, but we want to talk about each phase and give some stories and why businesses and brands need to think differently
and maybe push towards the next phase faster. So, Geoff, what’s the first phase?
Geoffrey From A2X (02:22)
I mean, I can start at phase zero, which is a brand that isn’t even, yeah, isn’t doing nothing, which you’d be really surprised, but working with thousands of brands, we’ve seen quite a few at the six figure revenue range only just starting to get started with their accounting. So I’d say that would be phase zero. But if you are listening to this podcast, you are probably at one of the next
Stephen Brown (02:26)
phase zero. Do nothing?
Yeah.
Yeah, do nothing.
Geoffrey From A2X (02:50)
four phases, which is great. And one of the cool things about this episode is you’ll really be able to identify yourselves within each of these phases. then kind of hopefully Stephen and I will be able to articulate what it would take to get to the next step and why that might be valuable for your business. So phase zero, you’re not doing anything. Okay, let’s get past that. Phase one.
Stephen Brown (03:09)
Yeah. Yeah, you’re nothing. And that works
until phase one, right?
Geoffrey From A2X (03:15)
Yeah, phase one until you’re starting to make money and you’re getting a little bit nervous that the tax man is probably going to start knocking on your door. So we kind of see brands wake up to accounting as a concept when they start making sales and knowing that they’re probably going have to pay taxes at the end of the year. So they tend to see accounting as necessary, but not necessarily valuable. The value of accounting typically comes in the later phases. And if you’re in phase one, you’re likely doing cash accounting rather than accrual. Stephen, you want to just quickly talk about the differences between cash and accrual just for the listener?
Stephen Brown (03:52)
Yeah, cash you’re basically, mean, cash is essentially what we do as individuals, right? We log expenses and income as we receive it on our bank account. And that works pretty well for individuals. It actually works really well. I don’t know anybody except for big accounting nerds who are accruing their personal accounting. The problem in business where it starts to fall down is when you’re doing like these big purchases or having big chunks of income that are spread over different timeframes and it starts to look really odd. So you’ll buy a big chunk of inventory in one month and then nothing the next and your profitability looks really wacky and it’s not really clear how your business profitability looks and how your business operations look. So that’s kind of the best way I could dumb it down is there’s actually a couple of rules.
Geoffrey From A2X (04:46)
Yeah. And I think that’s great. Right. And like speaks to why accounting is particularly important for ecommerce businesses, because like, in addition to the fact that like you’re, handling a lot of inventory, you’re also selling across multiple sales channels, multiple countries, you get paid out from Amazon and Shopify across multiple months. so it’s like, it’s, it gives you a better view of what’s actually happening in your business. But if you were in phase one, likely cash counting if you’re doing accounting at all. one of the things that has kind of led you to phase one is you’re getting ready to actually submit your taxes. So would be phase one. Stephen, anything I’m missing there before we get into phase two?
Stephen Brown (05:27)
No,
I mean, what I’ve seen with, with businesses on this phase one is they see, do accounting for my tax return for my tax accountant, make it go away. That’s, that’s the only value they attribute to their accounting. And, and these phases are additive, right? They’re more like kind of building blocks as your, your need to think about taxes never goes away. And there’s actually kind of a range of consideration. There’s people that are like, got to do it so my accountant can do, my CPA can do my tax return. Then there’s people that become more strategic about it. And they’re like, how do I minimize my taxes? But they’re missing, I think, the opportunity that the next phase brings. And they get stuck there, sadly. I see too many people just thinking only about accounting as tax.
and they’re missing the bigger picture that comes with the next phase, phase two.
Geoffrey From A2X (06:24)
Yeah, which is the phase that actually gives you visibility into how your business is actually performing. If you’re profitable, what products are profitable? What channels are profitable? Right? Stephen, you’ve given me this analogy on multiple occasions, but like accounting in phase two gives you a very good look behind for how your business performed in the previous year, which, you know, we’ll talk about this in a later phase, but as a building block to helping you kind of look into the future.
Um, phase two, you’re probably starting to transition into accrual accounting thinking because you want that better visibility into your business. Um, and there’s probably a few other dimensions. Stephen, I’ll kind of let you jump in and add them here.
Stephen Brown (07:09)
Yeah, phase two for ecommerce, I think you have to have accrual accounting because of the nature of product-based businesses. So there’s a couple of key things that become problematic when you’re trying and phase two is about understanding your business and understanding your profitability and what areas of your business are going well and what are not. So the reason you need accrual accounting, let’s kind of go down the different elements of an income statement. Number one, your income. Geoff, you were mentioning like
Amazon pays out in delayed things. So you get a payment in your bank account, but you probably earned that money days, weeks before. So that’s, that’s problem number one. So properly applying when you actually earn that revenue. The other big yucky nasty thing is cost of goods sold, which is the cost of the product that you’re selling. Now in a cash basis, you go in and you buy a bunch of inventory and you say, there’s my cogs.
and you don’t have cogs or cost of goods sold for like three months. The proper way to do this is to say, I sold a hundred widgets. What was the cost of those widgets? And apply that expense as cost of goods sold in the time period in which they were sold. And then there’s, there’s a lot of other treatments you could do around, you know, timing of marketing spend, timing of fulfillment, timing of payroll.
There’s other things. Those are the big things that most brands are thinking about. But the big two is when did I actually sell stuff and what were the costs of those sales that you need to get right in this phase two? Because everything kind of flows out of those two things.
Geoffrey From A2X (08:50)
And then from kind of like a financial metric perspective, if phase one, know, most, businesses in phase one in my experience are, you know, really caught up on top line revenue phase two, I think you kind of get a little bit deeper, right? Like revenue, although an important metric isn’t kind of the metric you start to think about the business from a profitability standpoint, you start to think about contribute the contribution margin.
What are some of the other metrics that you would say are probably kind the most important as you come into phase two and evolve past top line revenue?
Stephen Brown (09:24)
The things that I like to look at are, obviously you want to see your revenue and everybody knows the revenue from their sales channels, but I like to look at what is my cost of goods sold as a percentage of income. So what I’m going to describe is a whole bunch of what’s known as income ratios, cost of goods sold as a percentage of income. The inverse of that is a gross margin and gross margin is simply the profit after your cost of goods sold. So I like to look at that.
Typically, I like to see brands that are making at least oh, 40 % after cost of goods sold, um, up to 80 % because you’re going to need a lot of money left over for marketing, fulfillment, et cetera. So the other things that look at, um, are what is your marketing spend as a percentage of income? That’s a, that’s a killer thing, especially in recent years. And then finally, I like to look at fulfillment costs. So that’s kind of your core cost of sales.
You could also add in merchant fees, although those tend to be a fixed percentage of income, predictably around 3%. And anything that’s leftover goes towards your software, your payroll, if you have a warehouse or an office rent, and then ultimately profit. So I really hone in on those key areas. Your cost of goods sold, your marketing spend with particular focus on advertising and your fulfillment costs.
Because usually within those three things, I can tell if a brand is going to be successful or I can tell where the problems are if they’re not profitable. Sometimes they have really, those things are great. And then usually the next biggest culprit is their payroll. They’re spending too much payroll as a percentage of income.
Geoffrey From A2X (11:13)
100%. And what’s interesting, and I love the analysis that you’ve provided, and there’s intention behind why I asked the question, because typically phase two is when you actually start to work with an accounting professional to help you get to phase two, to help you make sense of the information and the data, to help you dig into these metrics. And Stephen, you did a really good job illustrating my point on kind of what tends to happen in phase two. Phase three,
Stephen Brown (11:25)
Hmm.
Well, before you go to phase three, I have a story. OK. And I also want to illustrate, it’s hard to do phase two. It’s expensive. That’s why you need accountants. That’s why you need tools like A2X. There’s a lot of information going on in ecommerce. It’s not like a service business like LedgerGurus.
Geoffrey From A2X (11:43)
please.
Stephen Brown (12:02)
It’s probably more complex than a SaaS business like A2X because they don’t have, you know, widgets moving around. just got a bunch of people and, and bits and bytes. So, but here’s my story. So I was, I was managing an enterprise security business about 10 plus years ago. And I had joined them right after MBA school. So I got new, I was my newly minted MBA.
And I’m ready to go and, you know, do MBA things. So I had some guys that I’d worked with at a company that had started another startup. said, Hey, come over and run product management. I was like, all right, let’s do this. Six months into my journey there, my CEO, who was really just a brilliant CTO. He basically let somebody else do the business side of things. He said, Hey, we need to make a change in the business leader. He and the board member.
previous business partner said, we need to make a change. Do you want to, are you willing to take over? was like, I guess, or why not? mean, so they didn’t really tell me what I was getting into. So I got into there and that’s where I was like, they’re like, we’re having some issues. We’re not selling as much. So I got into the books and started to analyze what’s going on in the business. Cause I using my new, my power of freshly minted MBA skills. What I found is we were running out of money.
They had ran a playbook of, let’s spend our way to growth, but it wasn’t working because we had issues with the channel that we were selling into. And I realized, crap, we have six months until we’re out of cash. So I got accounting religion like really quickly because I knew we’re running out of cash. We’re not selling the strategy we’re using isn’t selling. so we got to figure some things out. And I think, and that’s where I kind of started using some phase three techniques.
I’ve seen this with other businesses, we’ll go in and you’re like struggling and it’s like, first thing I’m trying to figure out is where, where are the problem points? If we’re not profitable, why are we not profitable? Like I said, I can go down and analyze a brand and usually within less than 30 minutes, I know exactly where the issues are. Oftentimes business owners have a sense for that. I think something’s off.
But when you have the numbers in front, it’s clear as day. This is where the problem is.
Geoffrey From A2X (14:19)
You know what the other entry point is to accounting as a religion?
Stephen Brown (14:24)
What’s that?
Geoffrey From A2X (14:25)
getting audited. I think there is no better entry point. We’ve seen that time and time again. People that tend to kind of like really move into accrual accounting, really move into like tooling like A2X to ensure accuracy and accounting partners like yourselves to make sure that, you know, everything checks out and reconciles our businesses that have gone through the arduous tasks of getting through an audit.
Stephen Brown (14:26)
oof that’s true that’s true yeah
Geoffrey From A2X (14:54)
the IRS in the United States. I’m based out of Canada, so we’ve got the CRA here in Canada. And everyone thinks it can never happen to them, and then it does, and they never look at accounting the same. They really, really start to understand the value of accuracy. Actually, in fact, I was at Ecommerce Fuel Live in New Orleans last year, and I was talking to one of the larger sellers there. I think they were doing about $30 million in annual revenue.
Stephen Brown (14:59)
Hmm.
Yeah.
Geoffrey From A2X (15:21)
they were selling custom tires. And he was telling me, just kind of like, went from like, accounting is necessary, but not valuable to accounting is valuable from one year to the next, because he went through a pretty epic audit. I hope that people actually come into the religion through…
Stephen’s path, which is understanding the value and the insights that it can provide to help you run a successful business. But then there is also kind of like a cautionary tale. Hopefully you don’t have to get audited coming through that door.
Stephen Brown (15:50)
Yeah.
Yeah.
Well, all that’s hard. The accrual accounting concept. I’ve got another story about a accrual accounting. So let’s go back a little bit further. Back 2006, I was a brand new product manager. And I remember we were in charge of pricing. I was at a Fortune 500 Symantec who’s since been acquired by Broadcom. Most people know them for the Norton company, which is now a separate business, but we were this big enterprise security company.
And I was, I was doing some pricing meeting and they, were bringing up at the time we sold software licenses and maintenance, which was your support and your, your rights to updates to the software. And so they’re talking about revenue recognition around the maintenance. And I’m like, what, what, what is, what is this revenue recognition thing? I remember going into my, one of my finance guys offices and say, okay, so the customer pays.
you know, you’re the license fee and then they pay for a year of maintenance all at once. And you’re telling me that we don’t, that we can’t apply that as revenue for 12 months. And so he proceeded to explain, well, we have to recognize the revenue over time because this was actually, they’re purchasing something that goes over a longer period of time. And it was total Greek to me. And it might be total Greek to you if you’re listening to this now. It literally took me, you know, I’m not like a full CPA.
I’m an MBA. I’ve taken a handful of accounting classes, a whole lot more finance classes, and I’ve hung around some really smart accountants for the last 10 years. But it seemed really stupid to me. Like, this is the dumbest thing in the world. Is this like some secret code that accountants use to make everybody else feel dumb? But once you understand it, once you kind of cross the chasm of, this tells a better picture of what’s actually happening. And the best way I could illustrate this for like an ecommerce business is you know, you get your cash comes into your account at weird time delays. So that’s problem number one. You know, you buy inventory a couple of times of year, but you’re selling it continuously. So if you were to go off of the time that you bought it, that this makes it makes it really messy and hard to understand what’s actually how profitable you are. And so accrual accounting, which is that part of that phase two is really important. This is not, you could learn this stuff online. You don’t have to go to college, you don’t have to get an MBA. You literally could go find some stuff on YouTube and probably cross the chasm on what these concepts mean. And once you’ve crossed, you’ll no longer think, those guys are idiots. You’ll think, that’s actually really smart. I mean, when did you figure out accrual accounting, Geoff?
Geoffrey From A2X (18:34)
Yeah. Luckily, I’m in Canada, so accrual tends to be the norm for us for all business accounting. We don’t have the option of cash. have to go accrual. But I’ll be totally honest with you. I’ve been doing this marketing thing for about a decade, but there was a short stint where I did some consulting and I had about five clients and I had to do my own accounting.
Stephen Brown (18:41)
Hmm. How socialist of you.
Geoffrey From A2X (19:03)
And you would think that a professional services business wouldn’t have a tremendous amount of transaction volume. I did in a lot of cases, like I was actually spending money on advertising and getting reimbursed by the businesses. I think kind of accrual provided me with sanity, gave me visibility into the business’s cashflow, right? Like it really just helped me run the most profitable consulting business that I possibly could in a world in which, know, previously to that, to your point, like these were tremendously foreign concepts to me. Now, obviously, because I’m not purchasing inventory, like I didn’t have as much pressure on my shoulders, right? Like my inventory was my time and the service that I provided, but like I’ve, you know, I’ve just, I’ve seen the light and I’ve seen the value of this. And I know that many businesses have as well.
Like actually, Stephen, do have any stories that are particularly in the context of ecommerce with some of your clients related to cashflow? Because cashflow, what I’ve seen, you we talk about, you know, accounting being make or break for brands. The break is usually they run out of cash. They can’t buy that next round of inventory. And a lot of the times it comes as a surprise. Like it’s a total surprise. They had no idea. And they hit a brick road and then…
Stephen Brown (20:03)
Yeah. yeah.
Yeah.
Geoffrey From A2X (20:27)
Like some of the things that I’ve seen happen is they get into a situation where they need to acquire lending and because they’re under a pressure crunch, they do so on bad terms and because they do so on bad, like they’re just behind the eight ball constantly because they didn’t have this visibility because they didn’t see this coming and because it like really threw a wrench in the business. So anyways, like I’m actually providing some anecdotal stories, but I’d love to hear if you’ve seen this happen as well.
Stephen Brown (20:39)
Yeah.
Mm-hmm.
Well, this one story that comes to mind, it’s less about cashflow and it’s more about revenue. Kind of piggybacking off of my, my example, I have a friend who’s been big in consumer products and he’s, he was head of sales at his previous company and he was telling me they did a ton of wholesale and what they would do is they’d get this initial purchase order and they were putting all of the revenue in that purchase order as revenue in that timeframe. I don’t know if they applied it all in one period or one month or one year, but what he was telling me is like the retailers weren’t selling at that rate. And so what happened is the follow-up purchase would be much smaller or they weren’t actually, I’m just going to throw out a number. don’t know if this is true.
They get a $3 million purchase order, but the retailer was only selling like a million a year. And so actually that purchase order was for a longer period of time. So he said, what happened over time was their, their revenue looked like it was going down when actually this was just, I was like, you should have recognized that revenue when it was being sold. Because over time it looks like, this business sucks. And they actually had a really killer offer. And.
It part of it was when they tried to sell, but I’m also like wondering like if the investor had seen revenue being recognized over time, would they have treated the business differently? Would that sale have, have closed cashflow? Yeah. Yeah.
Geoffrey From A2X (22:33)
Probably. Like we talked to you, like Quiet Light, who’s like an M&A broker. I’m sure many people who’ve listened to this podcast, are familiar with them and the valuations that businesses get when they have accurate accrual based accounting so that investors can have like real visibility into the business, can make an informed decision. investors acquire, sorry. you actually get better multiples on the business. So.
Stephen Brown (22:40)
Mm-hmm.
Geoffrey From A2X (22:59)
It’s like we’ll get into that in a future phase. So actually, it’s probably a really good segue into phase three, because we’re already skipping ahead to phase four on lending and investing.
Stephen Brown (23:02)
Yep. Yeah. Let’s talk about the fate. Yeah. So now you know what’s going on with your business. That brings us to phase three, which is.
Geoffrey From A2X (23:13)
Phase three, you start to look ahead. You start to forecast, you start to plan based on what’s happened in the past. Because you have visibility into what’s happened in the past, you could have at least an informed position on what may happen into the future. forecasting, financial modeling, super, super valuable. This is where I think accounting starts to become very strategic, right?
This is where people start to look towards fractional CFO services, or at times even bring CFOs in the house while continuing to work with an outsource accounting firm like LedgerGurus.
Stephen Brown (23:42)
Yeah, I missed it.
Yep.
Well, this is what I do a lot of. I’m the dumb MBA, dumb in that I don’t really, I don’t understand all the nuances of accounting. know enough to be more than dangerous, but I do a lot of the forecasting and modeling kind of picking back up off of my story. So I knew my, that going back 10 plus years, I knew my, business I was managing was in trouble and my accounting told me that. therefore what? Right.
Geoffrey From A2X (23:50)
Yeah.
Stephen Brown (24:14)
What I ended up doing is I that information to build financial models. built a model that would tell me predicted sale, know, basically forecast what are my projected sales and costs and all that and what’s the outcome. And I used that to make some hard decisions. I laid a significant amount of the team off, got down to like just survival level of head count while engineering was working on getting us, the ability to sell into other channels. And we did that over like a two year period. sucked, but I use that model. So I was using my accounting, my, my financial reports to determine if my, you know, how did we perform against the model? And then I would use that to update the model and continue to see like, how much time do I have until we’re out of or out of trouble or in more trouble. And I was able to get the business out of trouble and back into a good place. And then they had a nice exit a little bit late.
Geoffrey From A2X (25:18)
What’s, what’s interesting is you’re talking about, you know, using strategic accounting and, Forecasting and financial modeling as a way to support with, you know, survival mode. But there’s also the other side, right? Like there’s like the part is like, like, like, how do we use this to get into growth mode? How do we use this to plan out inventory purchases? How do we use this to plan out hiring, right? With our projected growth. Go ahead.
Stephen Brown (25:30)
Mm-hmm. Yeah.
Yes.
How do we use this to maximize profitability?
Geoffrey From A2X (25:47)
And go bingo, bingo, right? so level three, I think is when folks, you know, really start to see the light where they’ve transitioned from, okay, accounting is necessary because I need to file my taxes to, I can see why accounting is valuable in phase two, because I now can understand what’s happening in my business to phase three. accounting is now starting to get really strategic.
Stephen Brown (25:56)
Mm-hmm.
Yeah.
Geoffrey From A2X (26:13)
and is becoming a
Stephen Brown (26:13)
Yeah.
Geoffrey From A2X (26:14)
lever for us to achieve growth or, know, Stephen, in your example or to survive, right? Because like the reality of the situation is you’re gonna be in one of those two camps. Hopefully you’re on the growth camp, but it’s really, it’s really, really helpful when you’re in this level.
Stephen Brown (26:21)
them.
Yeah.
I’ve used kind of planning and forecasting in every business since that experience. And it’s, it’s the only way to go in my opinion. And I can’t, could I plan and forecast without accounting? Maybe it would be really, really hard. Right. And probably. Yeah. Yeah. You’re probably going to good accounting makes it so much easier. So, you know, back then I had, you know, counting.
Geoffrey From A2X (26:47)
Who would trust your numbers? Who would trust you? No one. I wouldn’t.
Stephen Brown (26:58)
accounting, building my financial reports. And then I was building the models. Um, kind of the same thing today. I, I have a team that usually does the accounting and then I’m usually building the models, but because it’s really, you kind of have to have a basis of what happened when you build a model and then you layer in, you know, Hey, we’re going to do all these different things. We’re going to go into TikTok shop. We’re going to go in, we’re going to deploy into app love and we’re going to do this. We’re going to do that. Or we’re going from just Shopify to Amazon or maybe going from Amazon to Shopify.
You build that baseline model and then you layer on, let’s put together some projections on top of what we’re going to do. And what does it tell me? And what I’ve used, the problem is when you just wing it, right? When you just kind of like go with the gut, like your outcome is very uncertain. When you do a little bit of modeling, it’s still not going to be exactly what you think it’s going to be, but you’re more likely to be in the right range. You’re more likely to understand, you know, the more time you spend trying to model things, the more likely you’re going to hit a desired outcome.
Geoffrey From A2X (28:05)
Yeah, I totally agree. Which is like a really good segue into phase four, right? Like, because if you have a solid accounting foundation that’s informing how you’re looking into the future through your forecasting and financial modeling, phase four really is when you have all of your financial statements are in a place in which they are accurate and they are clear and they’re able to be used in the context of acquiring lending, of bringing on investors, or of selling your business, because it gives those individuals the visibility that they need to make an informed decision. And the foundational accounting, right, is required for them to trust your financial modeling and forecasting when you are in the process of either getting lending,
selling your business or taking on investors. So that’s really where phase four comes in. Phase four is like, you now have financials that are pretty close to GAAP. You have financials that like are very clear and accurate, and that can be shared with confidence with third parties so that they can make informed decisions about your business. Anything else that you would add to articulate kind of what phase four is all about and what the value of phase four is.
Stephen Brown (29:24)
Well, let me put it this way. You may not value your accounting, but let me tell you who does. Lenders, investors, and people who want to acquire your business. And what we saw in 2021 and into the beginning of 2022, actually probably end of 2020 to the beginning of 2022, you saw this huge surge for ecommerce and you saw a lot of acquisitions.
Geoffrey From A2X (29:29)
You
Stephen Brown (29:50)
Anybody who went through that, some of them, some people went through a rude awakening because they’re like, Hey, my business is doing great. then somebody who was really savvy would come in and be like, what about this? What about that? And all of a sudden the value that you thought you had in your business wasn’t there because you hadn’t been accounting properly. I’ve got an example, if you’d like it.
Geoffrey From A2X (30:12)
Yeah, and that will like before even your example, we like we see thousands of brands at A2X, right? And during that period, the amount of deals that we’ve seen kind of like fall through the cracks, because they did not even have any accounting in place and then come and rush to A2X to be like, we need to get our books in order. Like we’re in the process of a deal.
Stephen Brown (30:19)
Yeah.
Geoffrey From A2X (30:35)
Like we saw that happen time and time again, which I’m wondering if it has anything to do with your story that’s upcoming.
Stephen Brown (30:42)
So, here’s the story. We had a customer, they were selling and probably one of the worst areas for ecommerce is inventory accounting. It’s super difficult. We’re going to talk about that in future episodes, but it was a decent sized business and the acquirer had employed a top, I want to say top 10 or a top 20 accounting firm to do,
review of what was going on. One of things that we had been telling them for years is you need to do an inventory count and just true up your inventory balances and whatnot. They didn’t do it. They didn’t want to do it. It’s hard. It’s kind of expensive. But what happened is they went up and they did this count and there’s this, it was a large number that was off. And so they apply that difference
to the most recent financials. At least I think they did. I never heard what exactly they did. I told them like, you guys haven’t done a proper adjustment for years. You should try and get credit and try and spread that over a period of years. But those previous years had been closed. had been, taxes had been submitted against them. And what the problem is, is like, let’s say you have to take a half a million or a million dollar hit. That’s a big number.
I don’t think it was that exact number, but it was large in your profitability in your most recent period. That’s what they value you against. So you’re eating past year’s mistakes, which ultimately can affect your value back then that was four, five, six, seven times your profit is what those values were. It’s not anywhere close to that anymore.
Geoffrey From A2X (32:03)
Hmm.
Stephen Brown (32:17)
And they took a huge hit because they hadn’t been doing proper accounting as they went, even though we’d been telling them, you need to do this process and you need to make those adjustments. So it could have cost them millions or at least a million in value. That hurts.
Geoffrey From A2X (32:34)
100%, 100%. And I love the statement that you made earlier around like, you might not care about your accounting, but you know who does? That is such an incredibly accurate statement. Third parties who are evaluating your business. So that would be phase four. So just to recap, phase one, accounting as necessary primarily so that you can file your taxes. Phase two,
Stephen Brown (32:41)
Yeah.
Geoffrey From A2X (32:57)
Accounting as valuable because it gives you visibility into the performance of your brand. Phase three, accounting as strategic because it allows you to use that historical information to look ahead into the future. And then phase four is accounting that is so rock solid that provides third parties with such visibility that they can make informed decisions to either lend you money, to invest in your business, or to acquire your business.
And, you know, kind of in the theme of make or break, right? Like at every single stage, you need to be doing this correctly because it can make your or break your business. In stage one, it can make or break your business in that if you’re only looking at top line revenue, you actually might be operating at a loss and have no understanding or visibility into that. And then by the end of the year, have less money than you went into it with.
Stephen Brown (33:37)
Yeah.
Geoffrey From A2X (33:50)
In stage two, what can make or break your business is if you don’t have proper accrual accounting and you don’t have great visibility into your cashflow and you come up to an inventory crunch or to a money crunch where you need funds, need to make payroll, that could really crush your business. We’ve seen that happen time and time again. And in phase three, like if you don’t have the foundational and accurate accounting to support your modeling.
A, think personally, you’re gonna have a hard time getting people to trust what you’re talking about is going to happen to the future. And it might be wrong, right? And it might lead the business astray. You might be planning for growth, but actually you should have been planning for survival mode, had you actually known what was happening in the business or vice versa, right? You might be missing a growth opportunity because you’re focused on survival mode, because you don’t really have that true visibility.
Stephen Brown (34:33)
Mm-hmm.
him.
Geoffrey From A2X (34:44)
And then on the make or break for phase four, like it could get in the way of lending or it could lead you to a situation where you’re getting bad terms. It could limit your ability to maximize your multiple during an M&A or sorry, an acquisition or even kill the deal altogether and it can turn investors away, really. So it is of critical importance at every stage of the process. And there are tools and there are services that can help you achieve your objectives, can help you get to the next stage, but it is of critical importance. Is that a decent recap of the four phases and as well as why they’re so important?
Stephen Brown (35:25)
Yeah, no, I
think you nailed it. like I said, you come in phases, but don’t get stuck or don’t ignore maturing your financial and accounting practices over other areas of the business. You need to be doing these in conjunction as your business grows and matures so that you don’t get limited by the lack thereof.
Geoffrey From A2X (35:48)
Yeah. And I’ll just make one mention. Like one of the things that keeps coming up is like this idea of accuracy, right? Like accounting by nature needs to be accurate. And there’s a lot of FUD that’s happening right now about, you know, artificial intelligence, being able to come in and automate accounting. And okay. Like I am, I am a tech optimist. I’ve been in tech for quite some time. I’ve, you know, I’ve seen the evolution. think that.
What we’re seeing in generative AI is probably one of the biggest technological evolutions that we’ve seen since potentially the internet, in my opinion, although I was quite young when the internet came to be, but that’s neither here nor there. And I do think that like maybe AI will be able to automate a portion of accounting or at least it’ll get help you get close enough. think in the context of ecommerce though, in a world in which you’re selling across multiple channels, you have multiple payment gateways.
Stephen Brown (36:28)
No, I would agree.
Geoffrey From A2X (36:44)
you potentially across multiple states or multiple countries and multiple currencies, given the volume of data and different data sources, think, accuracy becomes even more important in the context of accounting because, because there is just so much going on. We’re not talking about like a traditional professional services business. We’re not talking about like a monthly recurring task business. We’re talking about.
I highly seasonal, highly inventory dependent and multi-channel organization with just a tremendous amount of data, like accuracy in the context of ecommerce in my personal opinion, and I am obviously biased is of critical importance. I think that AI will help automate a lot of the process, but I don’t think that it’ll help automate the process in totality, just at least for the foreseeable future, in my opinion. I’m actually quite curious to hear what your opinion is, Stephen.
Stephen Brown (37:39)
I think AI is going to parts, potentially significant parts, but there’s a lot of work to do. so, I don’t know. mean, I’ve heard Bill, I think there’s a Bill Gates quote, like people underestimate how much progress they can do in a year or in 10 years, but they overestimate what they can do in a year. That’s kind of like AI. it’s.
Geoffrey From A2X (37:54)
in a year and yeah, that’s right.
Stephen Brown (38:02)
It hasn’t taken over the world yet, but maybe it will in 10 years. So there’s a lot of hype. There’s definitely some things that are beneficial today, but there’s a long way to go.
Geoffrey From A2X (38:16)
Yeah, yeah, I’m totally with you on that. I do think it’s interesting. And I’m like, very curious to see how this is going to evolve in the future. But one of the things, one of my favorite quotes is, you know, if businesses involve people, you’ll always need people on the other end to make sense of what’s going on. Because people inherently, like we just do weird things. We make weird purchases.
We make strategic decisions that are instinctive and gut to us, but on a piece of paper evaluated by artificial intelligence won’t have that context or that information. I always love that quote. If people are continuing to run businesses, you’re always going to need people on the other side to help them make sense of what’s going on.
Stephen Brown (39:03)
I agree. So let’s wrap this up. Geoff, if somebody wanted to connect with you, what’s the best way for them to do that?
Geoffrey From A2X (39:11)
I’m available on LinkedIn and Twitter. You can just search for me, for Geoffrey Guilano and yeah, be happy to connect and chat. I love talking about marketing. love talking about this topic. yeah, I’m thanks so much, Stephen, for, having me, congratulations on the podcast, way to go on your cadence. The fact that you’re at number three already and what we’re only January 8th is unbelievable.
Stephen Brown (39:27)
Yeah, thanks for joining.
Yeah.
Geoffrey From A2X (39:36)
I can’t wait to see this grow.
Stephen Brown (39:38)
OK, well thanks, Geoff.