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Saturday, March 31, 2007

Benefits of Proper Accounting

I realize most operations today have rigid accounting standards and excellent cash controls in place. In my corporate days, we tracked all cash daily from every unit. Using budgets and an automated accounting system, we closely tracked all changes in expected revenue and expenses. When I left this environment and started my consulting business, I sent out marketing materials to over 500 restaurant owners in the New York metro area. Some of my earliest clients had archaic accounting systems.

In these early consulting projects, I helped restaurant owners setup a chart of accounts, general ledger, balance sheet and income statement on several low cost accounting programs. I suspected some of these clients had "off the books" activities. I encouraged each of the operators to declare all revenue to the local and federal governments.

One of the owners asked me to help him out with a complete accounting makeover. He was breaking even and his cash flow was erratic. The restaurant was busy on weekends and weekday business was improving slightly. He had hoped to be saving a little for retirement as the business improved. Unfortunately, he continued to draw on his savings each month. I decided to review the entire control system for all working capital accounts.

Cash was not being deposited each day on a routine basis. Daily revenue and cash reports were not completed 20% of the time. Employees received a payroll check for their regular earnings but they were paid for overtime in cash. Certain suppliers were paid in cash. The owner also went to the produce markets early in the morning to save money. The cash used to pay the overtime pay and food supplies was deducted from revenue. I explained the serious risk he was taking with this approach. Further, I told him I suspected he had a thief in his operation. His poor accounting records served as a mask for the thief.

He believed he was saving a huge tax bill. I explained the total saved on each unreported dollar was 20% (sales tax, employers FICA, FUTA and SUTA) since he was breaking even. The total of this activity was 10% of his volume. Taking his view, I explained "the benefit" was 2% of sales. He actually believed it was 10%. I convinced him to rework his records, report the revenue, payroll and expenses properly and setup a system of cash management.

In the first 45 days, we discovered the thief and the owner was in shock. His "most loyal employee" was ripping him off for $5,000 per month (cash).

There are many issues involved in this project. The owner was jeopardizing a growing business with first year revenue of $1,200,000. He wrongly believed he was saving $120,000 by hiding revenue and expenses. In reality, he was losing $60,000 a year in cash (or 5% of volume). The $24,000 in unpaid sales tax, FICA, FUTA and SUTA payments represented a paltry return for this monumental risk.

He took my advice and paid all government agencies their proper fees. His business began producing a steady and growing cash flow. Since he now was showing a profit, the bankers loaned him money at rates far below the 15% his credit card company charges. His cash flow turned positive and he started saving $10,000 per month.

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