Businesses Lose Money From Bad Accounting

Your business is losing money, or perhaps just not as profitable as you think it should be. Here are two possibilities: your profit on each job or customer does not cover your overhead, or you are losing money on too many jobs or customers. Do you know which it is?
I’m always surprised (though I shouldn’t be any more) at how many businesses do not know the profitability of each customer or project or order they have. For instance, a sign company could not tell an associate of mine how much it cost them for an particular job they undertook. Their financial statements told them whether the entire business made money in the month, but on the months that they lost money, they were stumped: did they underbid their jobs, or spend too much money producing the work, or was their overhead too high?
At a more sophisticated level, a manufacturing job shop I consulted for had a cost estimate per job, but it included lots of overhead allocations. They could not separate out cash outlays from depreciation expense at the job level. The ace accountant Gerry Michael has an excellent short article on this topic, “Static Pricing in a Dynamic Market—A Dangerous Policy.” His point is that when business is soft and companies are not operating at full capacity, the cash expense of taking on an additional project may be much smaller than traditional cost accounting measures suggest. That manufacturing job shop brought Gerry in, he advised them to bid lower on new projects, and business started improving right away.
Strolling down the aisle of a trade show in the area of metal fabrication, I chatted with the owner of a cost-accounting software company. I assumed that everyone in the industry had a good handle on their costs by job—but I learned otherwise. Only half of the companies in the industry could accurately track their costs by project, he told me.
I ask companies how they bid complex projects. They usually say that they have an experienced estimator who works up cost estimates. I ask, “How do you know afterwards whether the estimate was accurate?” About half the companies have no after-the-fact cost analysis to evaluate the accuracy of the bid estimate. They tell me that Fred has been doing estimates for 30 years and he really knows the business.
Imagine a basketball player practicing free throws at the gym. Now turn off the lights so that the player does not see whether the ball goes through the hoop. Then add earplugs so the player cannot hear a swish or the ball hitting the backboard. How much does this kind of practice help the player? Similarly, if Fred has never gotten project-by-project feedback on what actual costs are, his estimates will not be very accurate.
If your cost accounting system is not up to snuff, or does not exist at all, where do you begin? The accounting expert Joe Schneid of AKT in Portland suggests “Develop and implement an accurate, consistent methodology to allocate expenses.” This is part of a bigger strategy, in Joe’s opinion, that begins with developing and monitoring budgets and ends with engaging the chief officers and the board of directors in monthly financial reviews.
Your accountant should be able to advise you on how to get that cost accounting system in place. If he or she seems clueless, then you have a tax preparer, not an advisor, working for you. Bring in a knowledgeable expert to help you get your system set up.

Source: www.forbes.com
Written by: Bill Conerly