The Store That Had No Balance Sheet
Sometimes, when a client fires you it is cause for celebration. It may also be a warning sign that you shouldn’t have invested so much energy in a relationship doomed to fail.
One of our clients, who I’ll call Bright Shiny, had fired us, a fact I learned when I was called to the conference room to meet with the successor accountants. “We’re the new accountants for Bright Shiny,” they told me. Judging from the eager faces of the tax manager and senior in front of me, I could tell they had no idea what they were getting into. So, my first words to them were: “Good luck.”
A startled look passed between them, as if to say "how bad could it possibly be?" After all, the CFO was a CPA and her husband, the CEO, had an MBA. Bright Shiny seemed like a thriving local business.
I later heard that as bad as it had been for us, it was just as bad for the new accounting firm and for the accounting firm that followed them. When the news spread throughout my firm that Bright Shiny had fired us, everyone cheered. Let me tell you why...
Bright Shiny was the main entity in a group of tightly intertwined family-owned businesses. The main entity was a store specializing in foods and kitchen items from around the world. Another entity held real estate, which included the store itself, plus rental space for several small businesses. One entity held a liquor license, while another was a wholesale operation.
Bright Shiny’s founder was the CEO’s father, who was still active in the business, even though he was in his 70s. Various family members held ownership interests in the different organizations. Other family members were employees of one or more of the different entities.
Besides the tax return, we also prepared annual compiled financials for them. The CFO used QuickBooks, but this was in the days before widespread use of bank feeds.
Payroll and total daily sales from their POS system were reliably recorded, but everything else was hit or miss. Cash was reconciled on an irregular basis, mostly as the CFO prepared for our annual work. They essentially had no balance sheet until we created one for them in the course of our work.
Bright Shiny really didn’t have an income statement either. I shudder to think that they were running a multi-million-dollar enterprise from their bank balance, but that was probably the only number that was anything close to reliable.
As the CFO finished up her bank reconciliations, which she did by hand outside of QuickBooks (don’t ask me why) she would always bring me a sheaf of papers with expenses that hadn’t been recorded in the version of QuickBooks she had given me. Most were purchases of inventory for the grocery store or utility bills, but some were fixed assets to be capitalized. She also brought me random scraps of paper with things like “parking lot paving $25,000, July 15, 2006” and “floor repair $18,000, August 7, 2006” written on them.
They couldn’t use their POS system to track inventory as items were sold because, as the CFO told me, “We sell things from all over the world. Some of the bar codes are the same.” Plus, her father-in-law was in the habit of putting things out in the store for sale without telling anyone. “We have no idea about these things until someone brings one to a cash register to buy it,” she continued.
They knew their markup on sales, so the CFO told us to back into COGS and plug the balance to inventory. Never mind the inevitable losses from spoilage and shoplifting that grocery stores always seem to have, that was the best approximation we could get to.
Like many family-owned businesses, the Bright Shiny group had numerous intercompany transactions. Some of these arose, the CFO told me, due to the way her father-in-law paid vendors. He routinely paid bills with whichever checkbook was at hand and that also had enough money in the account. That meant that a big part of the annual compilation was sorting out all the “due-to’s” and “due-from’s” between the related parties.
One of my co-workers spent several weeks one summer untangling a mass of complex transactions that went back nearly a decade. The grocery store would pay the property taxes for the LLC that held the real estate. The liquor license would pay the electric bill for the wholesale operation. The wholesale operation would pay for new cash registers at the grocery store…and so on.
Sometimes family members would loan a few thousand dollars to one of the entities and maybe would be repaid later. Sometimes it would be repaid by the entity they lent the money to, sometimes by another entity.
A year after construction of the new grocery store was completed, the CFO brought me a sheet of paper that laid out about $100,000 in additional construction costs for the building, which I had “forgotten to include on the prior year’s tax return.” When I asked her where the funds had come from, she told me her father-in-law had fronted the money.
A few months later, after we had filed all the tax returns, she told us that the total costs for the building were overstated by about $100,000 and that there was no way that Bright Shiny owed her father-in-law so much money. I did an analysis of the sources and uses of cash and discovered that those costs that I had “forgotten to include” had been on the balance sheet all along, albeit in a slightly different configuration. We were double-counting assets.
Of course, it was all our fault, like everything else wonky about their records. The CFO denied handing me the sheet of additional construction costs, never mind that it was in her handwriting. To keep the peace, the partner in charge had us amend the returns for free.
Their books were a mess and there was no way they could tell if they were making a profit or not. It was a huge ordeal every year to get their books together to do the compilation and tax returns. So, our in-house IT specialist proposed moving their accounting system from QuickBooks Desktop to something more robust. He even had a plan for dealing with the inventory mess. It would save them a ton in accounting fees and give them up-to-date information.
Initially, they said yes. But at some point, for some reason that we never understood, they suddenly went silent on us. We didn’t know that they had fired our firm until the new accountants showed up at our office.
What lessons should we have learned from this ordeal?
1. Some clients can’t be helped
While it would certainly have been beneficial to Bright Shiny to have had a functioning accounting system and to have had access to a higher level of intelligence about their business, they weren’t interested. As long as the cash coming in was still greater than the cash going out, they were happy. Maybe there will be a change when the father fully passes control to his son the CEO, but old habits can be hard to break.
2. Don’t try so hard with a client who doesn’t respect you
Except for the partner in charge, the CFO routinely blamed everyone she came in contact with at our firm for the problems in her books. She complained about every invoice we sent, but never did anything on her end to remedy the situation.
One year, I showed up at their office on the day we had agreed to start work, only to discover she wasn’t anywhere close to being ready. I packed up and left. It would have saved all of us a ton of frustration if the partner had fired Bright Shiny when the CFO first started blaming us for problems she caused.
3. Clients who value clean books make the best clients
We were limited by how much we could help Bright Shiny because all of us were flying blind. It was always a fire drill to get the compilation done so we could file the tax returns. They seriously did not care how chaotic their books were. They had enough cash coming in to pay the bills and to support a large extended family. That was really all they cared about.
The biggest lesson we should have learned is that we should never have taken them on as a client in the first place! Hopefully you will learn from our misake.
Liz Farr, CPA, spent 15 years in tax and accounting at small firms in Albuquerque, NM. Besides tax returns of all flavors, she worked on audits of governmental entities and not-for-profits, business valuations, and litigation support. Now she's a full-time freelance writer specializing in content marketing for accountants and bookkeepers around...