This is a follow up to a previous posting on September 6, 2011 Exactly How Do I Put a Value on Outsourced Accounting?
For some time I have been trying to find a definitive study on the value of accounting to a small business. Having spent the first 30 years of my career working for Fortune 500 companies, I understood budgets, forecast, and financial analysis as foundational to running a business. When I transitioned to entrepreneurship, I was surprised by both the lack of understanding and lack of desire to embrace operational accounting. Small businesses thought accounting was primarily associated with taxes. If you ask a small businessperson for the name of their accountant, they will give you their tax accountant.
eProcess Pros undertook a project to assess the objective tangible value (dollars in your pocket value) of providing quality operational accounting. We wanted to know if we could find proof that investing in accounting services would pay for itself. We had to have a consistent environment to analyze. We didn’t want product mix, product pricing, supplier sources or labor intensity to affect the comparative results. We needed a large group of similar small businesses. We found that in a franchises network. The franchise network allows us to compare performance on an apples-to-apples basis. Quality of management is still a variable, but we believe that there is a direct correlation between quality of management and quality of accounting.
First Finding: Operating Income Improved by 35%
Sixty-six per cent of the 110 locations used for this study provided meaningful information (see Methodology section for details). Average Revenue for the total group was just over $615,000. On average, they produced $42,000 in Net Operating Income. Costs of Goods Sold were just under 41%. Labor costs were under 20%. We tested against this benchmark. The second group, which was the quality accounting group, outperformed the benchmark in both Net Operating Income (which was to be expected) but also Revenue. Net Operating Income was up 35%. We expected that a business could optimize their expenses by paying closer attention to detail. Most of the improvement came from General and Administrative Expense. Looking at the two biggest expense items; COGS was the same and labor was 1.28% more favorable. A business would have to generate an additional $220,000 in revenue to achieve the same result that was derived from reducing expenses. This benefit alone would cost justify the use of a professional accountant who knows the way you run your business.
Second finding: Revenue was improved by 17%
The surprise was that revenue was up over 17%. We contacted some of the owners to discuss this phenomenon. The point they made was that better accounting information helped them make better decisions on how to allocate the sales and marketing resources. They knew what products to sell and what channels had the best success. They could calculate the marketing ROI, which drove higher sales with the same level of investment. Because they had accurate and timely information, they could make quick decisions to take advantage of opportunities as they arose. More importantly, they could avoid impulse programs that they knew would not drive the right products in the right channels.
We collected accounting information from a group of 110 quick serve restaurants which were all part of the same nationwide franchise network. We also collected the market demographic for each of the locations. We collected six months of accrual based Profit and Loss Statements. We categorized the statements into one of three categories; Group 1 consisted of 33.8% of the total, and was statements that were incomplete, inconsistent, or didn’t meet generally accepted accounting standards. Group 2 consisted of 13.6% of the total, and were statements that met generally accepted accounting standards, but were not
consistent, and Group 3 consisted of 52.6% of the total, and were the statements that met general accounting standard, were complete and consistent. Consistency was defined as not deviating more than three per cent from the norm in any given category over the term of the study. We used groups two and three for our analysis.
We then normalized the data by making sure that the right data was associated with the right category. In many cases, this required conversations with the owners to get clarification. Using the normalized data, we applied standard statistical analysis methodologies to derive norms for each category. We used this normalized Profit and Loss Statement as the benchmark for the study.
We then took a subset of the Group 3 contributors that replicated the market demographics of the entire network. We did this to eliminate the possibility that those locations that emphasized the need for high quality accounting were also the biggest revenue producers. To achieve the right demographic profile we used only 11 locations. We produced the norms for each category to create the Profit and Loss Statement.
We then compared the quality accounting group results with the benchmark group results.