OK, let's get this straight right at the beginning. We're not trying to become a modern Shakespeare, nor are we are suggesting the start of a jihad against accountants. The 'Hutchinson' in White Hutchinson is a CPA and we use accountants on a regular basis. However, as much as accountants are necessary to the operation of any business, they have in some ways become a detriment. The biggest problem is with their standards for recording and presenting financial business results. It all makes sense to the accountants, but unfortunately it can be accountantese Greek to business people. Further, it does not present a clear picture of what is really happening with the business and can introduce a bias in the businesses management that works to the detriment of success. Here's two situations we have observed in the location-based entertainment industry to illustrate these points.
The accounting standard for presenting a business' historic financial performance is the profit and loss statement, which first lists revenues and then subtracts expenses, with the difference hopefully being a profit. However, many a business has gone broke while making a profit or has been successfully generating cash while showing a loss. The problem with the P&L format is that:
The accounting profession has tried to correct some of this with what they call the EBITDA statement, earnings before interest, taxes, depreciation and amortization. This is somewhat equivalent to cash flow before debt and taxes. However, for LBEs, this method misses a very important item, replacements, which can gobble up a lot of a year's cash flow.
Accountants also will create a Sources and Uses of Cash statement, their version of a cash flow statement. However, it is an extremely convoluted statement, as it starts with line items from the P&L and then makes adjustments to convert it to cash flow. I have read these statements for many years, and still have yet to figure out how anyone (other than an accountant) can understand from the statement what the heck is going on with the business. I sometimes wonder if the accounting profession created the format so accountants can bill more time when their clients come to them for an explanation.
In the work we do with clients, including financial pro forma projections, we start with a true cash flow statement that includes provisions for replacements. This is a cash flow format that tells you exactly how much money will be left in the cigar box at the end of the year - a simple but essential concept to understand, as cash is king. The most important thing for any business, and the very essence of survival, is the ability to pay the bills. That is the first thing any business owner needs to understand, because if you can't pay your bills, you're toast. We then take the cash flow statement and convert it to EBITDA and then to a P&L, just the opposite approach of accountants. Our clients can easily see exactly what probability their businesses have to pay bills, debt, investors and survive. There is no mystery to it. They don't need someone to translate the financial reports for them.
Probably the best example of how the P&L introduces a bias that works against the success of the business is that it treats labor as an expense. Yes, you have to pay employees, FICA and all the related taxes, but the problem with treating labor as an expense is that the focus becomes keeping labor expenses as low as possible. First and foremost, front-line employees, those who are the touchpoints with guests, are an asset, not an expense. They are key to your business success, as they are the ones who shape your guests' experiences and determine:
Second only to your investment in your facility and equipment -- no, probably first -- is your employees. They are not some expense item that should be minimized to maximize profits. Yet, that is what the accountants, at least in their formatting of financial reporting, lead us to believe. In fact, just the opposite is true. Investing in good employees, which often means paying more, increases revenues, thus increasing profits. It is the front-line staff that really takes care of the financial bottom line. However, the P&L fails to reflect this relationship, or that a higher expense can actually result in higher profits.
Yes, it is important to monitor labor expenses, as labor is the largest controllable expense of any LBE, but not necessarily in the way the accountant's P&L would have us believe. You need to monitor the labor cost, but also the labor quality and its relationship to revenues. Just think of the Wal-Mart greeter, a labor expense, but obviously one that has led to improved customer satisfaction, revenues and profits. Otherwise, Wal-Mart wouldn't have greeters in every store. They increase labor cost, but more than increase revenues to offset that cost.
One of the worst biases we see this "labor expense" mentality create is the idea of keeping hourly wage rates as low as possible to minimize labor expense. As the expression goes, "You only get what you pay for." There is a big difference between a minimum-wage hourly employee and one worth $10 an hour. The more expensive employee is often more responsible, productive, experienced and better skilled at guest interaction, resulting in more business and actually a higher productivity rate per labor-dollar than the "less expensive" employee. With higher paid employees, you also tend to have less turnover, another important consideration, as they get to know the business and guest better. Employee turnover is very expensive to a business, as it creates many costs, including hiring and training costs.
Costco is the most successful retail warehouse club operator.
Despite working on very thin margins, the company pays their employees
more than do any of their competitors. If you have ever shopped at Costco,
you can't help but notice the employees' productivity (they
hustle) and friendliness, both factors in Costco's competitive