This white paper discusses the ‘accounting gap’ issue for small businesses – an issue that MUST be resolved for any small business to become a successful larger business.

Smaller businesses face a serious disadvantage compared to larger businesses when it comes to financial management support. This can leave management unsure of how the business is performing and with a limited understanding of how the drivers of profit are behaving. This puts the business at a high level of risk, impacts its ability to raise finance, and ultimately devalues the market value of the business if the owners wish to exit.

There are 4 major problems that cause this issue. They are problems that are not easy to overcome but they can be managed, and the business can be set up for success. Strategies need to be determined to manage and then overcome these problems. The four problems can be referred to as

  • The finance purpose problem
  • The information needs problem
  • The recruitment problem, and
  • The economics problem

The following article outlines the nature of each of these problems and offers suggestions for appropriate strategies to address each of them.

The Finance Purpose Problem

This problem is best defined as a lack of clarity around the importance and value of the separate finance functions. Broadly speaking, the major finance functions are:

  • transaction record management
  • cash management
  • tax compliance
  • financial controls
  • monitoring & reporting performance
  • treasury management
  • financial planning & analytics

Some of these functions are a requirement for a business to operate. If the first three categories are not undertaken with sufficient diligence and accuracy, the business will quickly get into difficulties.

Financial controls are needed to make sure the financial accounts are accurate but controls such as formal accounting policies and balance sheet reconciliations are often neglected in smaller businesses. Ensuring revenues & costs are recorded in the appropriate reporting period is also an area that is often neglected in this type of business.

The final three categories are the key management tools of the business and are critical to business decision making. They have complete reliance on the integrity of the financial controls process to ensure they are meaningful and provide management with the information it needs to make good decisions.

Underlying causes

The reason there is a finance purpose problem in many smaller businesses is due to owners or senior management often not fully understanding or valuing the importance of the financial controls process in ensuring that management decision making can be based on accurate and meaningful information. This is particularly the case in those businesses that have grown from a centrally managed structure (i.e., owner made all the operational decisions) to a decentralised one where functional managers are making operational decisions. In many cases, these functional managers have not had direct experience with this type of management, and so are not fully aware of the value & importance of information that truly reflects the performance & position of the business.

Strategies for addressing the problem

Firstly, management needs to recognise that the management practices that worked successfully in the past may not be as successful in a more complex management structure. Senior management is now relying on reporting to understand performance where it was able to observe performance more directly in the past.

As the business grows and management structures become more complex, the focus of senior management will need to move from an operations management focus to a strategic management focus. The importance of reliable and meaningful information increases in importance.

“Firstly, the business needs to align its information needs to its management processes.”

A part of the role of senior management is also to hold the functional managers accountable. This is just not possible if the financial reports are not totally reliable. An example is where sales and operations managers are required to achieve gross profit margins targets of 35% but where monthly reports are not reporting gross profit accurately.

Once senior management fully appreciates this, it will be in a position to start resolving the finance purpose problem. To achieve this, it is critical to access the appropriate skills and experience. As the economics problem will show later in this article, for many small businesses, it is not practical to recruit a finance professional with these skills & experience. However, the emergence of the virtual CFO industry now means small business can access these skills within their budget limitations.

The Information Needs Problem

This follows on from the initial problem. Once management has fully embraced the value and importance of reliable and meaningful information, it needs to address how it can access this information in a timely manner.

While this includes both financial and non-financial information, the issue is that data sources need to be structured to enable the data to be available, and the management of these data sources need to informed and consistent. The structure of the general ledger is the first structure issue that needs to be addressed.

Transaction tracking categories, job management software, CRM software and other registers are examples of other data that will be important for management reporting. Structuring the sources of data will rely on the management needs of each company.

Whether it is about profitability of product categories, territories, or channels; or, whether it is about operational efficiency or cost management, the structures of data sources are important for attaining meaningful information.

Underlying causes

The reason this problem exists will generally be due to on or more of the following factors.

  • The business has not developed an information needs strategy that aligns data availability with management needs
  • The data sources have not been designed to support the appropriate information needs
  • The business lacks the resources to undertake this process. This can include business intelligence (BI) applications such as Power BI or even well-developed Excel based analytics
  • The business lacks the skills to manage the process

Strategies for addressing the problem

Firstly, the business needs to align its information needs to its management processes. What does the business need to understand how well it is progressing towards achieving its strategic objectives? What does the business need to understand how well it is performing at an operational level?

For the business to undertake the high value adding activities of performance reporting, treasury management and financial planning & analytics, it has to understand what the drivers of business performance. It also has to understand how these drivers behave and affect overall performance.

To resolve this problem the business needs to include strategies to address the problems specific to that business. Having the skills and experience that are required to support this is an essential requirement. As with the first Accounting Gap problem, for many businesses, it will be uneconomic to simply recruit the skills and experience into the business.

There are many consultancy businesses that can help with establishing the informational framework that the business needs. We believe that a strong financial management background is important as the alignment of the information with the management needs is a critical success factor here. Many virtual CFO businesses will have both the financial management experience and the data analysis experience to provide these services within the business’ budget constraints.

The Recruitment Problem

The recruitment problem is basically the difficulty that small business has recruiting high quality, motivated finance professionals. Finding candidates with a high level of experience is an important factor. These are people that, not only have the technical skills, but have worked with successful teams and understand what management needs for decision making.

They also need to understand how to build and nurture the foundational structures that will enable them to fulfil their role and really make a difference to the successful performance outcomes of the business.

Underlying causes

To understand the causes, let’s break the potential candidates into two main categories.

  • Highly skilled and experienced finance professional
  • Developing finance professionals

The second category need to work with members of the first category to understand how to support a business and its management teams in the most productive manner. The only other choice is to learn from your mistakes and do lots of research. This is a costly way to achieve the desired outcome. How costly? That depends on the nature of the mistakes that get made.

For many small businesses recruiting someone from the first category is just not possible. There are many reasons for that. Members of the first category will need

–      An appropriate remuneration packaged
–      Ongoing career development opportunities
–      Prestige associated to the company they work for
–      To be surrounded by strong teams and high-quality systems

In most cases, small businesses cannot supply these to the candidate. Therefore, any attempts to recruit this type of candidate is likely to be an exercise in frustration.

And if they are successful in recruiting this type of candidate, it may be a worse outcome than not finding someone. The new recruit may be disappointed by poorly developed systems that they are being forced to work within. They may be frustrated by the different management culture that does not value what they do sufficiently. They may also be frustrated by the lack of knowledge and skills of the team members they are working directly with.

Consequently, most small businesses will recruit from the second category when developing their finance department. This often means they are not addressing the problem of building the finance department that will enable them to successfully grow into a larger and more profitable business. Instead, the finance staff will work with the systems and structures that are already in place.

Strategies for addressing the problem

The way to address this problem is to find a contracted resource to help you develop the strategies & systems that will enable you to have a high, value-adding finance department. A part of the mission of that contracted resource will be to help you develop your internal finance department over time.

The pace with which the internal team should be developed will depend on a range of factors. As the final Accounting Gap problem will show, the size of the business and the profit levels achieved will be a key determinant of the timeframe within which this can be achieved. For many businesses, this could be greater than 5 years.

It is very important to establish that the contract advisers have the experience and knowledge to complete the project, and that they can provide critical financial management input across the entire period that they are involved.

With the emergence of the virtual CFO industry over the past decade, there are now many options available for small businesses to find a suitable virtual CFO to work with.

The Economic Problem

The final Accounting Gap problem has already been alluded to on a number of occasions in this article. It is the affordability issue.

Underlying causes

The economic problem is principally one of scale. The scale issues impact in a couple of ways.

  • Return on investment, and
  • The part-time nature of the various roles

The return-on-investment issue is clear. A business with a gross profit of $10m will get a much higher return from employing a well-paid staff member for a specific role than a business with a gross profit of only $2m. But it is the nature of the work that is the biggest problem of scale.

“The virtual CFO can undertake the higher-level tasks within the budget that suits the business while working with senior management to develop the team as the business grows. “

A finance department consists of many roles. There are accounts receivable and accounts payable roles. There are payroll and entitlements management functions. There are financial accounting roles, financial controller activities, reporting & analytics, and planning & treasury functions.

In a small business, there may be no full-time roles amongst all of these functions. The consequence is that staff will need to take a number of functions as it is not practical to have numerous part-time staff all undertaking a specific role.

As you get to the roles that require higher levels of knowledge and experience, this multi-tasking requirement will have an impact on job satisfaction. An experience financial controller, who has spent many years gaining the knowledge and experience needed to carry out this function, will not find it rewarding to be managing the accounts’ payable function. Nor will they feel like this is adding to their career development opportunities.

These are the common problems that act as a key barrier for small business as it tries to build the finance team that will help it to achieve its main objectives.

Strategies for addressing the problem

Once again, the strategies begin with being aware of the nature of the problem and to make use of experience contract services to assist with the development of the finance department in line with the growth of the business.

The best strategy for addressing this issue is to appoint a contract financial management adviser to develop the systems and oversee the finance functions. Like most things in life, the answer is not black or white. A level of multi-tasking cannot be helped in a growing finance department. If you have your most expensive resources undertaking lower skilled tasks that could be completed just as well by someone on a significantly lower wage rate, the cost of this function is greatly increased.

Now that there is a well-established virtual CFO industry, there is a clear opportunity for growing businesses to appoint a virtual CFO to work with the business. A virtual CFO can tailor their scope of work to match precisely what the business needs. The virtual CFO can undertake the higher-level tasks within the budget that suits the business while working with senior management to develop the team as the business grows.

The modern working environment & the role of virtual CFOs

The problems covered in this article are no longer a necessary constraint for small business. Technology has now provided a platform for working seamlessly with contracting service providers. Cloud based applications are now common in most businesses.

Even the changes to working arrangements during the pandemic, where working from home has become a standard part of the daily routine. Business is now attuned to working with a combination of office based and work from home arrangements.

Contracting a virtual CFO to work with the business will include other benefits for the business. An established virtual CFO will have invested in models and planning systems. The cost of development will have been defrayed over many clients and many improvements are likely to have been included from feedback received. This means the client business gets access to well developed models without the need to pay staff to develop their own models. In some cases, the virtual CFO business will have dedicated model development staff on their team enabling modelling and analytics that might not be achievable without them.

Another benefit is that the virtual CFO is being exposed to many different businesses. This brings perspective and can mean the CFO has experience issues and resolutions in other businesses that can be implemented in the client business. The standard practice for virtual CFOs is to enter into a non-disclosure agreement before commencing work with any client business.

The constraints on small businesses are real but there is no longer a necessity to endure this problem. New technologies and the emergence of the virtual CFO industry now provides growing businesses with a productive and affordable option to address the problem.

The Virtual CFO Group Australia has well-developed financial control processes that it uses with a range of clients. These have been developed for a range of business types with operations that include manufacturing, service delivery, 3PL, and wholesale/retail – both within Australia and internationally.

These processes have helped many finance teams to establish more reliable reporting and review environments that support productive decision-making.

Colin Wright is the principal of The Virtual CFO Group Australia. He is a founding member of the Association of Virtual CFOs. The Virtual CFO Group has provided virtual CFO services to a range of client businesses for the past 9 years. They have worked with a range of client businesses, some of whom have experienced growth levels of as high as an average of 65% per annum over more than 5 years.