When starting a business, hiring a finance person is often an afterthought. Many businesses engage in what I call “shoebox accounting”: dumping all their receipts, bank statements and invoices into a shoebox and handing them to an external accountant who provides a Notice to Reader and files your taxes with the CRA. This is a very typical situation that I walk into as a consultant and in every circumstance, not only is there a lack of critical information on the business, but the financial statements are always completely wrong.  

A Notice to Reader is the most cost-effective method for an accountant to put together financial statements, because it comes with a disclaimer that says the accountant relied completely on the information provided by management and did not do an audit. In other words, your accountant doesn’t give a shit if the numbers are right because their ass is covered. To do a proper set of books, someone actually needs to understand every transaction, and a lot of questions need to be asked. Here are the most common issues I find when entering a small business:

• Entrepreneurs often pay attention to the profit and loss statement because they care about revenue, but do not even look at the balance sheet. The balance sheet is absolutely critical to an investor, especially because it provides information on the value of assets owned in the company, any debt outstanding and the equity structure for your shareholders. When I open the balance sheet, I ask a simple question such as: “so you have only loaned the company $100,000?” The response is often “No, the company owes me much more. [Insert number 4-5x here]”
• Business owners often know their aggregate gross margin and often even know the gross margin on every product they sell. But if I ask a question about the net profitability of each business division, they can’t answer because they have not broken out operating costs. For example, if two different products are yielding a gross profit of $100,000 each, but one product is taking up more staff time, space in the building, and higher marketing costs, the overall net profit is significantly different for the two. Operating expenses are often lumped together in consolidated statements and not broken down, so business owners are unable to gauge real profitability for each product and division.
• I often see small businesses doing cash-based accounting, instead of accrual-based accounting. What this means is that they are inputting revenue and expenses based solely on when money was sent or received on the bank statement. This is completely wrong, as revenue and expenses should be inputted based on the month the services were rendered. For example, if you pay 3 overdue legal bills in March for $50,000, most small companies book $50,000 of legal expenses in March, when really the bills were for services in January, February and March. When you run your financial statements, it looks like you incurred a huge legal expense in one month.
• Inventory is rarely accurate. I have seen the same inventory balance on the balance sheet several years in a row, which cannot be possible. Creating a process for inventory count is complex and requires expertise.

When beginning the process of raising capital, the investor will ask questions about your margins, as well as aspects of your business you haven’t tracked. All of a sudden, to meet investor requirements, you need to go back 2-3 years and manually extract the information being requested. If you seek help from your external accountant, this now turns into an extremely expensive project. Therefore, it literally pays to hire an accounting professional early on, to set the accounting system up internally so that it tracks information that you will very likely need for a capital raise.