It would seem elementary that monitoring the accounting and finances of your business is an essential control for effective management. But why then are so many business owners guilty of having no idea of the financial position of their company? I see case after case of business owners who are shocked to find that their company is insolvent, that obligations which they personal guaranteed are in default and that they are liable for an assortment of unpaid trust fund payroll taxes? My inquiries with these individuals has lead me to the conclusion that it all comes down to a simple failure in basic internal control procedures; nobodies monitoring the financials. In response to my inquiries I get justifications such as, "Well, I reviewed the bank account balance daily", "I pay a controller to watch that?" or "I got annual financial statements from my CPA". In response to the first I explain that bank balances don't show you your liabilities, to the second I ask "so who's watching him?", and to the third I question, "What do you look at for the rest of the year?". A recent client whose business we just finished winding down told me that he didn't feel like he needed to monitor his business. He was acting largely in a limited capacity providing the capital for the business while another partner acted as the managing member. I asked my client whether he ever received any financials from the managing partner. His response was no, he was relying on the managing partner to review those. So I asked the managing partner whether he was reviewing the financials. His response was no, the other partner never asked for them so he never bothered. Can you have a more obvious example of "the blind leading the blind"?
Business owners need to put a strong monitoring system of their finance and accounting at the top of the list of priorities. Monitoring is the first step in understanding the true financial position of your organization. If your idea of monitoring is checking the bank balance each morning you need to consider implementing or hiring someone to implement an actual accounting and reporting system. If you already pay someone (controller, CFO, bookkeeper, etc.) to monitor your organizations finances you need to have procedures in place to hold them accountable and verify that monitoring of the financial is in place. A good start would be monthly budget-to-actuals and variance reports. Finally, if you are looking to your annual financial statement audit as your source of monitoring (ah hem, listen up here board members) then understand that for 364 days of the year you are completely in the dark. Why not engage your CPA to provide monthly compiled financials if you don't have the internal resources to do it. In any case, if you ignore this vital organizational control don't feign shock when delinquent notices, tax liens, default and foreclosure letters, etc. start showing up and you suddenly find out that business isn't as rosy as your bank balance may have lead you to believe.
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An alternative to your alternative
@danzitting Your statement that the deeper flaw is that business owners tend to not understand accounting is correct. You mention that business schools teach to focus on the P&L instead of the entire financial statement (especially the balance sheet). I would go one step further to say that it is much worse in that they also seen to push the cash is king concept resulting in most business owners essentially managing their business from nothing more than a glorified check register. I do have to disagree with your statement that failures should not be blamed on a lack of internal controls though. No amount of understanding of accounting will prevent a failure if there are inadequate controls in place to make sure what is reported is actually right and that monitoring is actually occurring. Thanks for commenting!
A slightly alternative perspective...
Great topic to post on, thanks. I wrote up my own perspective on this on our blog, eatinghours.com if interested. Short version is that I think the problem runs a little deeper with owners focusing far too much on earnings numbers rather than their financial position according to the balance sheet because they really don't understand accounting fundamentals.