[15] (Part 5: Finance Department – The Three-Headed Monster) De-Risk Your Biz: Minimum Small Business Legal Requirements

Three-Headed Monster: Your Finance Team

First you might ask: what is a lawyer doing talking to me about finance? The answer is that the point of this blog series is to identify key areas of business risk and de-risk them. Not having the proper financial systems in place is a huge risk that I see all of the time. While it may not seem like having the right financial team and controls in place is a legal issue, the lack of having those things leads to a host of problems for the business which all have legal implications. If you don’t have your numbers right and aren’t tracking them properly, you’ll make poor decisions which can cause potential damage to all of the stakeholders of the company – from your investors all the way to your employees.

The biggest common mistake that I see in small-medium businesses is the lack of organization of the finance team for the company, or not having one at all. You need three different functions within your business’ finance team in order for you to generate accurate financial statements and to stay current on your tax obligations: Bookkeeper, CFO and CPA.

Your bookkeeper is the person who takes the time to categorize all of the incoming and outgoing money that flows in and out of the company. Money coming in is usually either your sales receipts or some sort of refund. It needs to be categorized properly and match to invoices generated by the company, all of which can be accomplished in simple accounting software like Quickbooks. Accordingly, the bookkeeper is also well-positioned to be the person who is most familiar with all of the little details of the company’s cashflow and spending. They also usually handle generating invoices and collections when payments are overdue. 

Your CFO is a glorified title for a financial manager. For smaller companies, this role doesn’t require much other than pulling together all of the categorized work from the bookkeeper and making sure everything is properly placed into financial statements. I don’t do a deep dive on financial statements here, but for a primer I recommend reviewing the following resources:

Quick Overview: Investopedia – Financial Statements: List of Types and How to Read Them

Deeper Dive: Book – The Portable MBA in Finance and Accounting

Understanding financial statements is a much bigger topic than can be covered here, but it’s always a red flag when the CEO or management team doesn’t have at least a basic grasp of the three financial statements for a company and how they function.

Your CFO is also responsible for helping the CEO and rest of the management team forecast into the future. This is accomplished by creating a financial “model” or forecast that makes certain assumptions about the company’s anticipated performance, both in terms of money in and money out, for the next few years. The model serves as a tool for the management team to periodically revisit those assumptions and see what happens to the company’s financial performance when certain things change. The idea isn’t to create a perfect crystal ball and try to predict the future, but you need a tool to use as a roadmap and be able to analyze what’s happening, right or wrong, when things go or don’t go according to plan.

The third role on your finance team is your accountant or CPA (CPA = Certified Public Accountant). Your CPA should be a licensed person who is duly qualified (i.e. they have to take exams and pass them in order to become a CPA) and are responsible for preparing and filing your tax returns and other tax related filings. This usually includes more than just annual tax returns. Your CPA should also be analyzing your business to determine whether you owe sales or use taxes, or issues like whether you have contractors who should be reclassified as employees (or the other way around), which can trigger payroll tax obligations. Plus, various states have different types of taxes for property, excise taxes and the like. As your business grows, so will the complexity related to taxes. It’s important that your CPA understands the context of your business – what your business does, how you provide products & services to your customers, and what your future plans are – so that they can stay ahead of the game and help you anticipate how your tax situation might change. This info then gets relayed back to the CFO to make sure that tax considerations are built into the financial forecast. 

A common mistake is to outsource all three functions to your CPA and their team. There are plenty of CPAs out there who employ bookkeepers in-house and offer those services. I don’t have a problem with that. But more often than not the CFO piece is missing and it’s arguably the most important. Without someone to verify your financial statements and help you understand them better, you’re walking through the financial forest without a flashlight.

In my opinion, you are better off finding three people to play the different roles, since each role requires different qualifications and skill sets. A bookkeeper can be in-house at the company and should be someone who becomes intimately familiar with your business so they can easily categorize all of the cash inflows and outflows. You want this person on standby to answer questions and make adjustments as you go along. A CFO may be the hardest role to find, especially for smaller companies. Small company owners generally don’t understand how to put together financial statements and therefore find it difficult to hire someone else who does. There are business management companies out there who provide these services, although not easy to come by. Take your time with this and find the right person. If you get those first two roles right, the CPA’s job becomes relatively easy since they are just taking the financial statements from the CFO and using the info to generate tax returns to let you know how much tax you owe. 

The punchline: CPAs are not CFOs and don’t usually provide much in the way of financial statement analysis; make sure you find a capable CFO to fill the middle role.

The risk of not setting up your finance team properly should be obvious: without a solid system in place to monitor the company’s financial performance, you risk running out of money and not being able to track how you’re spending the money you actually have. If cash controls aren’t tight, founders tend to make more mistakes due to panic when the numbers aren’t coming back the way they “thought” they were. You want to take the “thought” out of it and have financial statements you can rely on. When you have the right financial team in place, you don’t have to guess about your numbers. 

Finally, another big risk for the company is carrying overdue tax obligations. You can get away with paying suppliers a bit late sometimes, although it’s not something to make a habit of, but if you owe the government money you must pay! It could be argued that nothing is more distracting for a CEO than finding out they owe more tax than they thought and worrying about how they are going to come up with the extra cash and still run the business properly.

In the next post, we’ll switch gears and talk about intellectual property – a subject that most business owners are a bit mystified by, so I’ll try to keep it simple.

De-Risk Your Biz: Minimum Small Business Legal Requirements