Accounting for the financials of your emerging brand can be a daunting task, but the sooner you get to it, the better it will be for you in the long term. In this episode, you will be treated to some best practices that might help you go through this arduous but ultimately rewarding task. Elliot Begoun gets into the heart of this matter with Heidi Huntington, Principal of AVL Growth Partners, a Colorado-based full stack CFO firm specializing in early stage and high growth brands. Some of the valuable nuggets that you can find in this episode are the importance of starting early with meticulous data recording, the advantages of accrual accounting, the value of creating cashflow projections and manual tracking of inflows and outflows, the difference between fixed and variable trade spends and so much more. Most valuable of all, you will learn what differentiates a bookkeeper and a strategic accounting partner and why investing in the latter will save you a lot of cost and trouble in the long run.
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Accounting Best Practices For Emerging Brands With Heidi Huntington Of AVL Growth Partners
Before we jump in, as always, a bit of housekeeping. This is a show that features your questions. We want to answer the things that are top of mind for you and give you actionable advice and things that you can take back to your businesses and use. That only happens if you ask the questions. I’m going to introduce Heidi, let her tell us all a bit about herself and AVL Growth Partners. Heidi, thank you for joining. I’m glad to have you here. Please share a bit more.
Thank you for having me. I’m excited about our conversation. I am what is called a Fractional Share CFO with a company called AVL Growth Partners out of Colorado. What we do is we create a full suite of finance, accounting, and strategy anywhere from services at the accountant level all the way up to the CFO strategy. I do spend quite a bit of time working with food brands. I do work in a few other industries but I would say 70% of my focus has been in the natural food industry both for companies that co-pack and manufacture. I have enjoyed helping these companies grow, mature and navigate what is being a food company.
The first question is why the hell are we doing a show on accounting? That’s better than melatonin. I get it. That’s how many of us react but there are those of us who are nerds and we do enjoy spreadsheets, numbers, and so forth. In all seriousness, it’s a topic that we don’t discuss enough and talk enough about especially for early-stage brands. The importance of having rigor and discipline around your numbers, accounting, and financials. It impacts everything. It impacts your ability to make good fact-based decisions, the ability to foresee potential cliffs or challenges in it, and it impacts your ability to fundraise. Not only do you need good numbers to identify what it is that you need to raise, but as you go through the due diligence process with any potential investor, the quality and the clarity of the financials you put in front of them often become the deciding factor as to whether you get that funding or not.
That’s why it’s important to discuss it. There’s more than calculating EBITDA, gross margin and all of that. These are often the KPIs that are your roadmap and your indicators of how you’re doing, how you’re performing, what’s going and so forth. If you choose to use this episode as melatonin and it gives you all a better night’s sleep, then I consider that a job well done too. It’s totally up to you. No pressure. I do have the voice that put many to sleep so I get that. I’m going to start things out and ask a question in terms of best practices for early brands and what they should be at least having as a bare minimum regarding financials and rigor around financials.
For emerging brands, it’s important that you start off early with recording your data set. Your data sets are your transactions, anything from your accounts payable, the way you’re recording your inventory, to the way that you’re creating your invoices to your customer. Making sure that you have a good nomenclature, a standard way of recording information into your finance system whether it’s a Zero, QuickBooks or whatever accounting software systems that you have thinking long-term about how you’re recording that data and what standardization are you doing because that data helps you create your roadmap, find your trends, and understand the story of what your data is telling you how well your company is doing where there are issues or not.
Recording that data, looking in a standard way, looking at it month over month, and understanding what it’s telling you is going to give you that roadmap but it starts with the data. That’s where we tend to see issues happen when brands finally come to a company like mine or others that the data set is so messy that we can’t make heads or tails of what’s happening within the company so that we can come up with a strategy of scale, growth, sustain, where we need to invest, and where we’re overspending. Paying attention early on to that data set and looking at your historicals month-over-month and understanding what’s happening is going to create that roadmap for you that’s going to allow you to be successful much quicker because it’s the concept of junk-in, junk-out.
If you’re making decisions based on bad data, incorrectly recorded data or missing data, you could make some missteps that could create issues for your velocity or you could be taking in credit memos and discounts that aren’t yours to take. How is that impacting your financials? Are they too big? When we start with the early-stage brands, that’s the one thing that they can do even on their own early on if they can’t afford fancy accounting is. Make sure you have a standard way of putting your data in the system so that you can pull it out, understand what it’s telling you, and it’s the same every month. You didn’t do it one way in one month and a different way another month. That’s what differentiates brands early on.
Would you recommend that one of the starting blocks is to establish a good chart of accounts and clarity in terms of what are the buckets you’re going to be filling with the different information, how you’re going to label, and operationally define those buckets?
If there’s one area that if you invest a little money early on is reaching out to others in the industry and make sure that you’re setting up your chart of accounts in an industry-standard way. Food manufacturing is different than a lot of other industries. It’s important that even if you invested some time or even a little bit of money to make sure that the chart of accounts you are setting up is correct for this industry and what you’re trying to accomplish, that will help you immensely in the long run.
One of the things I see is that a lot of early-stage brands take what I call the ostrich approach to accounting. They stick their head in the sand and hope to God they never have to see their numbers because they’re scary. They’re a reminder of the risks that they’re taking. I always try to encourage founders to think of it the other way, that numbers are freedom. They give you choice and visibility. How would you share with entrepreneurs about how they should view numbers, data and the importance of having this to be better founders, better entrepreneurs?
That’s where the starting point becomes what I talked about earlier is how you enter the data in. Data is important because it is the story of what’s happening in your company. You need the historical data. You need to be looking at what’s behind you, what’s been happening, and looking at any trends. Any things where you can see things that are occurring at the same time or things that have a lot of variabilities and trying to make heads or tails around why that’s happening. Is that the way it should be? Is there a reason it’s happening? Is it a timing issue? Is it a data issue? You have to understand what’s happening historically in your company so that you can take that information and create a forecast and look into the future. The way that I describe the need for good data, good financials is like driving a car.
When you’re driving a car, you do have your rearview mirror. It’s a small piece of glass but it still is important to be looking behind you, seeing what’s happening behind you, educating yourself what’s going on back there. Do I need to be aware of something if someone is going to hit my bumper, whatever it maybe? Where we need your vision is through the biggest piece of glass, which is the windshield. That’s where you’re making a lot of decisions as to where you’re going and educating yourself when you’re driving or when you’re looking at your financials. Using your historical financial data, to be able to create assumptions or theories about where you think that your company is going. From there, creating a forecast at least 24 months out, I know that in early-stage that’s painful because there is a lot of guessing but using that historical information will allow you to create a baseline of assumptions of where you think it could go based on your best understanding of what’s been going on.
Accounting For Emerging Brands: For emerging brands, it’s really important to start off early with recording your data. That will become the starting point for your roadmap.
That’s what allows you to understand what your needs are going to be in the next two years. Is that a cash need? Is that CapEx need? Is that more resources? Headcount? If we don’t invest in a salesperson, do we think we can get that top-line revenue? That forecast is going to paint the roadmap and that picture of where you’re going to go. It doesn’t mean that there’s not a pothole up there that you didn’t anticipate. There are always things in front of you that you couldn’t have anticipated. If you have a baseline of assumption, it allows you a better understanding of how to move around any of the hurdles, pitfalls, or changes that occur. A lot of early-stage companies that I work with, COVID being one of those was an interesting time. Because we had solid board assumptions, we were able to pivot and manage that situation a lot better than some of the other companies that didn’t have that forecasting component and using that data to drive their business forward in a proactive way rather than simply reactionary.
Of the many soapboxes, the regular audience to this show knows where I stand on. One of them is you have to build a growth hypothesis of where your business is going to be including revenue sources, key expense buckets, capital needs from working capital, etc. for the next five years to be able to plan appropriately. It’s good to hear that. I always thought that a little glass mirror in the middle of it was to see what I had stuck in my teeth when I was driving.
You can use it for that as well. I’m probably missing a few things but how you look in your car is important.
Gregory has a question. Gregory, it’s nice to have you here. What good resources exist for entrepreneurs to get educated on the “standard way” that these are brands that are bootstrapping and may not be able to immediately afford a fractional CFO?
There’s no magic bullet but here’s a whole library of information on specifically what you need to do. There are a lot of different organizations like Naturally Boulder, NCN or TED Talks where you’re going to be able to get access to resources that are going to be willing to share a lot of information with you early on and be able to have access to a lot of those very basic beginner questions. They host a lot of seminars on specific topics like this. For food manufacturing, a simple topic would be, how do I manage my trade spend? A lot of people are like, “What do you mean trade spend? What does that look like? How does the industry break it out?”
There are a lot of opportunities out there, different communities that you can join where they will funnel down into very specific topics that allow you to understand what are the best practices. In all honesty, they’re shifting and moving especially in the natural food industry, quite swiftly a lot. Being a part of not just one of those communities, but a few of them and tapping into them. There are a lot of heavy resources that are an inexpensive spend that will give you access to a lot of those specific industries normalizing pieces of information, guidelines, and best practice.
A couple of things to add to that. Bob Burke does a couple of seminars each year on financing and numbers that are very detailed and helpful. Another good resource is fellow founders, people who are a little bit ahead of you in the process because they’ve gone through the pain and suffering so they know what’s worked and what hasn’t worked. You’ll find that many of them would be willing to share basics, everything from chart of accounts to how they’re dealing with unifying key deductions so don’t be afraid to ask. All of it has to be the concept of GAAP. That’s specific which is a generally approved accounting practice. As long as you’re following those guidelines, you’re in good shape. Here’s another question. As an early-stage brand, if I could only focus on a few things, what should I be focusing on around accounting and numbers?
We’ve covered one of the large focal points which is it all starts with your chart of accounts. I agree with you 100% on the food industry is very generous with their share of information, mentorship, and propping up other brands which are awesome and utilizing those individuals as mentors. That’s a nice thing. It goes back to what I talked about at the beginning which is if you have a good solid chart of accounts and that set up to industry expectation best practice and then, you mentioned GAAP Elliott, you start to differentiate on the difference between GAAP and cash accounting. A lot of early-stage companies record their data based on when cash is moving in and out of their company which makes it difficult to find trends because it makes your financial results lumpy.
You can’t figure out what your margin is or what were my COGS, Cost Of Goods Sold, is associated to the units that I sold because I recorded all my raw materials and COGS on my P&L that I didn’t sell all of the units that were associated to those raw materials. Understanding cash accounting versus accrual accounting which is more of what you were talking about, Elliott, which is under GAAP. Accrual accounting meaning when was the revenue earned is when it hits your P&L and when was the expense incurred. Not when you paid the bill. I paid someone for services in November, but I didn’t get the bill until January. I need to put in data into my accounting software in November to represent that spend even though I don’t have an invoice yet. When you start doing your data on accrual accounting. It’s going to make your finances much more informative and powerful to give you that roadmap.
If you can do that early on and spend the time reaching out to different people to discuss how should I do this? What does accrual accounting mean? There are lots of amazing quick YouTube channels that will give you the down-low on how to do that. Lots of resources. If you were to solely focus on a chart of accounts and making sure that you’re recording stuff on an accrual basis and you know what belongs on the balance sheet, meaning your inventory for stuff that hasn’t been sold, any invoice values that haven’t been paid, any expenses that you haven’t been paid, and you don’t even have an invoice. How do I get that on there? If you can do those basics now, you will be well-ahead of the game much earlier on because you’ll have data that’s giving you a better roadmap earlier on. If you had to say, “I can only focus on what are the three most important things.” For me, that that would be it because the rest you can pivot, move, change, and reorg. Those are the three critical ones.
I’m going to add to that a bit. First of all, I learned that I have something in common with cash-based accounting and that is we’re both lumpy. A lot of people use cash-based and they look at it and thinking that they’re managing cash. You said something that is hugely important. When you look at your P&L and accrual-based P&L begins to help you see trends in your business. It also helps you begin to see the correlation between actual sales, actual COGS, real margin and all of that. If you have that to look forward, that’s your trend, and you’re being able to see how your business is performing period-over-period, this month versus last month, your date versus a year ago. All of that is hugely helpful.
Accounting For Emerging Brands: Historical information allows you to create a baseline of assumptions of where you think it could go based on your best understanding of what’s been going on.
The other element though is your cashflow. As Andy Whitman with 2x says all the time, cash is king and there is nothing more important in the long-term ability of a brand and an early-stage founder to succeed than their ability to be on top of their cash and know exactly how much they have, where it’s going, and where it’s coming from. Speak a little bit about cashflow, how to track it, and how important it is to an early-stage brand.
It goes back to what we talked about earlier is having a forecast because you want to be able to predict where your cash is going well and know that if you’ve got a cash issue. How big that cash issue is? when it’s going to happen? What period of time is? How do you forecast that? How do you understand that? How do you know that? You forecast out your P&L and then your cashflow is essentially going to be when your balance sheet and running P&L off of accrual, not cash in and out. Accrual meaning there’s going to be things on your P&L that you haven’t expended cash on yet or you could have already expended all the cash, and it’s showing a portion of it on your P&L.
One of them would be an investment in capital expenditure, depreciation coming onto your P&L. That’s not the cash spent, you’ve already spent the cash or you haven’t because you might have a loan. The way that you look at your cash is you take, “This is what I think my P&L is going to be.” I have to look at my balance sheet and understand where have you already spent cash or where have you not yet spent cash? What are those increments and decrements? Looking at your balance sheet and the changes in your balance sheet are going to drive where your forward cash is going to land. It starts with your P&L but it ends with understanding future purchases of capital expenditure, raw material, or if you’re co-packing. What are the terms that I have on the co-pack material that I’ve procured to sell?
Is it 60 days? Being able to model that out on your balance sheet is going to allow you to understand when your cash might get tight and what scale it might get tight so that you can then decide how you might want to go out and bridge that GAAP. Do you want to raise equity? Can you pull it off with debt? Do you want to do something that’s called a convertible round, which is debt with the intention to convert to equity so that you can get a little farther along and have a little bit better valuation? Understanding and forecasting cash out at least two years is going to be helpful and you having enough lead time to put together what you want it to look like, how much you need, and what leads you’re going to do. Who is the type of person that you want to talk to?
What are you pitching them? How well do you know your numbers to support your pitch to people? You don’t want to not be paying attention to your cash, only looking at it in the month that you’re in or in the past, and not understanding what it could look like eighteen months out because fundraising can take a while. If you all of a sudden realize we’re out of cash in six weeks. It’s going to be tough for an early-stage company to get debt. Even that will take quite a while. You can’t be like, “Go get a line of credit.”
That’s still going to take even if you’re able to pull it off 45 to 60 days to close on something that. Fundraising, if you’re going to do a price round, an equity round, or a convertible note that would go to equity. It’s going to allow you the time that you need to get that secured and in place. There are some short-term things that you can do like factoring and things like that but a lot of times, if you purely do the planning, you can be able to bridge those financial GAAPs without it costing you an arm and a leg. That’s that point of looking forward and understanding what your needs are from a cash perspective.
Looking at your business, when you’re going to run out of cash is no fun and it’s scary. It is scary to confront that but it’s a whole lot better to do it in advance than to be at the cliff. First, if you do anything, you’re likely to make subpar deals because when you’re desperate, you take deals that you necessarily wouldn’t or all you can do at that point is curl into a fetal position with a flask and hope to live another day. Neither of those is what’s best for your business. Being able to foresee it, know, and be realistic. Those of you who work closely with me know that I’m a big proponent of physically manually tracking your inflows and outflows routinely.
Gary Hertzberg always says that entrepreneurs are pathologically optimistic. We do our cashflows and think that we’re going to get cash in sooner than we do. Our spending is going to be slower or less than it is. The benefit of doing a projected cashflow and then putting your actuals down right next to it as you begin to unearth your own forecast here, your own bias, and you become better at seeing the reality and not selling yourself a bill of goods. Lauren has a question, Heidi, “Is there a good rule of thumb on how to budget and track for trade versus marketing? What about Whole Foods? Of 2% or 3% or early payment at the distributor, do those go into a trade or other sales reductions? What are the best practices?”
You bring up several and they belong in different buckets but the category that you brought up is that GAAP accounting again. It’s called contra revenue and it lives up in gross margin right below your revenue from the units that you’ve sold. It lives right below that and there are negative numbers in that area of your financials before we get to the cost of goods sold. One of the ones you brought up is in the discounts like 2% net 10%. We don’t truly consider that true trade. We consider it a discount for doing business. We don’t put it in trade spend necessarily but it is in that contra revenue. Me and different CFOs view these things differently.
This is where it’s more like art, not a science. As long as you have it up in contra revenue, the way you categorize it there, some industry best practices where you have two different buckets for trade spend. You have variable trade spend. That’s the trade spend that’s always ongoing like you talked about a little bit. Sometimes it’s that 3% partner fee that you have from whole foods. In order to be able to sell on their shelves, you have to play the game so you have to have that 3%. That’s variable trade spend because as long as you have that relationship with that retailer, you’re going to have to do off-invoice with them. You’re going to have to do scans and promos, and do their required 3%. That’s variable trade spend.
You then have fixed trade spend, which is considered more like one-time trade spent. Say that you have a free fill that you’re going to do because you’re coming on all the shelves of sprouts or what have you. That’s considered fixed trade spend because it’s a one-time concession that you’re getting in order to get on the shelves. That’s fixed and it’s tied to opening up new points of distribution. If they pay you a slotting fee where you’re either having to buy your way onto the shelves or get in their computer system, that’s not a free fill of your actual product. That’s all fixed because it’s one time. Sometimes there will be a few one-times that you have.
A lot of them have category resets so you would have to pay it again but we still consider it fixed because it’s not quite this ongoing relationship of discounting that you’re giving an off-invoice, a scan, and MCB, or a spoils freight allowance. Those are all areas that go up in that contra revenue account. The best practice is to have a variable trade spend, a fixed trade spend and then having some information under that. That’s powerful when you go to fundraise because looking at trade spend is something that a lot of the savvy food investors look at. They want to know how you’re supporting the growth of your brand via trade spend. How’s that impacting your ability to open doors? ACB or velocity is the number of poles off the shelf.
Accounting For Emerging Brands: By putting your projections right beside your actual numbers, you will become better at seeing the reality and not selling yourself a bill of goods.
Lots of nuggets there. I’ve never heard accounting being referenced as an art. A little frightening but cool. A few things, first of all, this comes back to the beginning of our conversation around the importance of setting up the rigor of a good chart of accounts because that becomes the menu or the playbook in which you put expenses. This is an opinion. When it comes to any bucket but in particular things like contra revenue, there’s a fine line between parsing it out too much, therefore, causing yourself more work, potentially more confusion, and parsing it out enough.
You want to be able to see the things that you need to see in order to sell. One, make good decisions and two, to sell your proposition as investible. That trade spend is one of them. The allocation towards trade spends that is growth-driven trade spend versus other contra revenue like discounts, etc. One of the things that are key and this leads to another question in a minute which is how to prepare your financials in a way that is going to position you well in front of investors? Before we dig into that, Lauren has a follow-up question. Is there a “perfect range” for trade spend?
There is a way that it’s viewed and it depends on where you live in the store. Shelf-stable tends to have less variable trade spend need than if you’re in the freezer. The refrigerated, because it’s more perishable, tends to be the most expensive trade spend relationship because of what they require to make sure that your product is moving often through the shelf because of where it lives and it’s perishable, it’s expensive. There’s not as much room in the grocery for it where there are all these inner isles of a shelf-stable product. There are some sweet spots there. It depends also on what phase your company is in early on. I always call it putting nitrous on it because my son loves cars.
Everything in my house becomes a car reference and it now bleeds over into my job. I can give you benchmarks. We view best practice when you’re trying to get velocities and stake down your claim on the shelves of retailers. If you’re shelf-stable, you’re somewhere between 15%, 18%, 19% is a healthy spend. A lot of companies can spend a lot less but their velocities and growth will most likely be a lot slower. If you don’t have the cash to invest to get you up or the margin on your product to be able to give that concession of 18%, 19% of your top-line sales to trade spend, you can do it, it slows the velocity.
That’s why we call it nitrous. If you’re in the freezer, you’re looking at somewhere between 18%, 22%, and 23%. It tends to be a nice guideline. If you’re refrigerated, it’s the most expensive engagement and you’re somewhere between 20% and 28%. It depends on what your shelf life is on your refrigerated product. There’s a lot more variability but it is the most expensive. You can spend less, it slows that velocity so you need to be prepared for that. When I say a percentage of it, it’s of top-line sales when I’m giving you percent.
I have a couple of things to add to that. First of all, Lauren, I’ll answer your question a little bit more directly. There are a lot of moving parts to it. Category for sure and all of that but your pricing architecture. That’s where a lot of brands miss the opportunities to think through what their pricing architecture is. If you know you’re in a category where upwards of 70% of the volume in that category is done on the deal then you need to build in your pricing architecture that model. That may mean that your everyday white tag price is higher than ordinarily you would think but if you’re in the 70% plus VOD category, you’re likely not going to spend much time at your white tag price anyways.
If you’re at your white tag, it doesn’t matter because when you’re off promotion, you’re going to be surrounded by other people on promotion. It’s only going to be your most loyal customers. You got to think about pricing architecture first when it comes to trade spend. You’ve got to look at the category you’re playing in and what’s the better structure. There are a lot of moving parts. What I find too often is that brands come out at what they think their price needs to be or their competitive price point. They get into the promotional rabbit hole, start going down there, and then they wonder why their gross margin sucks. Know the category dynamic first. For example, the ice cream category. The ice cream category is I guess the volume on the deal is somewhere 90% and the switchability meaning the willingness of consumers to go from brand to brand based on ads is high.
If you know that going in, you have to buffet yourself for that. The other thing is there is some truth to the fact that scale will help solve for COGS. As you grow, you see that but too many brands and founders sell themselves that concept as being too true. I don’t always see that manifest because the other thing scale does is usually drive down price point because, in your earlier days, you’re usually at your highest price point, you’re in the more specialty stores. As you move more towards conventional mass, there’s more downward pressure. As you become more ubiquitous in the market, there’s more downward pressure. That scale is keeping you constant with margin, it isn’t getting you ahead.
All those things should enter into it and it should be an important, well-thought-through aspect of strategy, not something that you feel compelled to do. If anybody ever wants to have that discussion, you all know where to reach me. Jenny has a question, “When hiring a bookkeeper or accountant as a small brand with limited resources, what questions to ask to make sure they truly understand our industry before working with the big firms that we know and understand?” The one question I always ask is did you ever work for Bernie Madoff? That’s a good first icebreaker. Heidi, any suggestions there?
That’s a good start. With that, you need to ask them have they ever worked with a company that has worked with the inventory. How do they treat inventory? What we see a lot with bookkeepers is whenever you buy your raw materials or even when you buy co-pack units, immediately goes on the P&L, and it doesn’t belong there. It sits as an asset on the balance sheet until you sell it. You only recognize it for the units sold. That’s a big one to spend a lot of time talking to them about inventory. The second one is how much experience have you had with accrual accounting versus cash accounting?
Those are the two largest areas of cleanup that we see when we get a brand coming to us that needs a lot of help and clean up because they’re trying to raise funds and their financials are not in the right shape. If you spend a lot of time in those two categories, talking with them to make sure that they understand the food industry is important. The third one and it is harder to find someone that knows it. It’s a matter of testing to see how much desire they have to learn is the trade spend. Understanding the contra revenue that we talked about, the trade spends, and how to record that properly is important as well. It’s a lot harder to find a bookkeeper and accountant at an earlier phase that’s done it. If you feel you have a good grasp on it and they’re willing to learn, that’s a teachable piece of information. It’s a lot harder to teach an accountant nor do you have the time, should you teach them accrual accounting over cash accounting, how to do, and manage inventory.
Another question too is ask them for the name of their parole officer. If they don’t laugh and then they start offering you a name, that’s another a-ha moment. In all seriousness, there are enough brands in this space that you could crowd surf a good bookkeeper who understands the basics of this. I want to draw a distinct difference between a bookkeeper and a strategic accounting partner because it’s a different thing. It’s great to have a bookkeeper. A bookkeeper is helpful. They’re taking things from your plate that aren’t your highest value activities and getting them done.
Accounting For Emerging Brands: Savvy investors really look at how you’re supporting the growth of your brand via trade spend.
They’re making sure that things are going in the right buckets and doing those things but they’re not a strategic partner in the fact that they’re not trying to help you understand what the score is telling you and also helping you foresee what this score means for the long-term. It’s important to know the two. One of the things that I see far too frequently is that brand SAC dates. They think they have a real accounting, real CFO level type support on their team when they’re in fact, leveraging a bookkeeper. When it comes to fundraising and it gets to that level of detail, you’re having to answer to your financials and you can’t, that’s where you recognize the difference.
To add on to that, that is an important piece. I appreciate you bringing that up for sure. The bookkeeper is going to be able to record the data in the best manner that they know and that you instruct them. There’s a lot more oversight in the bookkeeper and they’re not going to be able to tell you the story of what your financials are telling you and the accuracy. There are some amazing bookkeepers but they’re much more process-oriented. When you start getting into a higher-level strategic accountant, controller or CFO, that’s where the accuracy of the data and the story of what your data is telling you start to unfold.
That is a lot harder to develop when you have that bookkeeper resource unless you’re savvy in finance, and that’s a strong suit for you as well. The other component is a lot of people in early-stage brands are like, “We’re bootstrapping it where we have a small amount of cash that we can spend. We want to save money there and we can.” What they don’t understand that a lot of companies that we work with learn much later on is you end up paying more in the long run because when you get to the point of fundraising and scale where you need that true finance and accounting, much more strategic, much more elaborate support and recording and things like that. In order to square away what happened early on when you were bootstrapping, instead of it costing you a small amount of money, you’re now in four times more than what you saved in going the cheaper route with a less experienced bookkeeper.
That’s one lesson that I would learn as well when you’re comparing between accountant. That’s a little bit more expensive but has the background, the knowledge and the skill versus the cheaper resource, the bookkeeper. Don’t make it a comparison, make it on the individuals and what they bring to the table for a food brand rather than about how much money you’re saving. I realized that’s an important time and time again. It will, in the end, cost you more to go with the cheaper but not experienced enough to be able to pull it off.
This is a core part of building a business. It is foundational to it. If you don’t have a good strategic accounting foundation of your business, do you risk building a business on a house of cards? I’ve seen it, I’m sure Heidi, you’ve seen it too many times where it happens and it falls in on itself. There are places to be scrappy and be thrifty. There are places to invest to see all that as it takes money to make money. You’ve got to do some things on it. I got another great question for us, “Is there an industry standard for an advertising cost of sales for an eCommerce digitally-native brand? Have you seen them?” I think what he’s referring to is as a percentage of eCom revenue. Is there a standard or is there something that you see about how much of it is reinvested in acquisition to add a business?
ECom is an interesting model when you’re forecasting out and evaluating it because eCom has driven from the middle of the P&L. It is driven strategically through marketing and advertising. What is your reach out to your consumer base? What are your site visits? What are your cart visits? What is your conversion rate? It can very much be heavily determined based on what’s happening in marketing. What are the marketing strategy and the plan? It’s hard to say what is the best practice, the average or a range there for marketing in an eCom business especially advertising because it’s a matter of knowing when you’re investing. I’ve seen eCom companies invest in enormous amounts like $60,000, $70,000 a month on Facebook, Google, all of their social media, and to see little site traffic pickup.
It is more a matter of when you choose to do whether it’s advertising, a social media push or something like that to get velocities off of your site up and going. You have to be paying attention in real-time to what traction it’s getting you. Did that increase your site visits? Are you doing a promotion where it’s like, “I wouldn’t get one free?” Did it increase your cart value? Did it increase your conversion rate? Paying attention to your backend metrics when you launch a strategy or when you do a push out of a big Monday morning social media push.
Do you always see on Monday, Tuesday, Wednesday spike and then a fall off? It’s hard to say is there a best practice. The best practice is when you’re doing the advertising, pay attention to what your backend data is telling you on your website as to how the market is reacting to what you’re offering. What is it changing? What is it not? Is it not doing anything? Pivot and move quickly to be able to recapture some of the spendings that you’ve had and transition it to something that might work a little bit better. That’s the best way can answer it because that one is similar to trade and where you are in the story. It’s not a simple answer.
I’ll answer the same way I answered Lauren. It’s all over the place. We don’t have a ton of time left so I’m going to take some moderator’s prerogative and ask some questions that are important. One is you’ve spoken to it a few times but I don’t know that everybody understands the importance and what exactly the balance sheet is. It’s a 30,000-foot understanding of what is the balance sheet and how is it used?
I will try to make this not something that will make people go to sleep. You have three different sets of financial statements. You have your P&L, which shows your activity, your revenue in, your expand out. You have your balance sheet, which is your assets and your liability. Your liabilities and how much money you would either put in or someone else has put into your company. The balance sheet is important because the balance sheet represents where you’ve invested cash whether it’s putting cash in the bank, investing in assets, assets being inventory, assets being fixed assets like any machinery that you have, office equipment, whatever it may be then you have your liabilities. What are those?
Bills that have come in that you haven’t paid. It’s payroll liabilities. It’s some loans that you have. What the balance sheet, as those values go up and down, you could have something as simple as a prepaid expense. I had to pay for my trade show booth in September but Expo West isn’t until February. I’m paying the cash-out but I don’t want to put that on my P&L yet. This is where we get into accrual accounting. The balance sheet becomes important in accrual accounting because we’ve spent cash. It’s not my account but I don’t want to put it on the P&L because you recognize something like that in the month that you do that trade show, not when you pay for your booth. That’s where you get the lumpy financials.
Where do I park that? It’s an asset because you’ve paid to have the opportunity to do something. You park it on your balance sheet, your asset. It represents the cash that you’ve spent, you have spent that you’ll get the benefit later that showing on your P&L, or it’s an expense that you’ve incurred that you haven’t yet paid. Does it tend to be that representation of how have I spent money that hasn’t come through my P&L except for in the equity section? Your results of your P&L come back to you in your equity section of your P&L as either retained earnings from past year’s results on your P&L or as net income that is what is the current year’s results.
Accounting For Emerging Brands: Anything that you’ve put on your balance sheet on accident sits there and haunts you forever until someone goes in and really cleans it up.
The reason why the balance sheet is important is that it allows you to understand how you’ve spent cash that isn’t on your P&L yet or do you owe cash that also may not be on your P&L. That’s where you get to understand what is my obligation? Am I upside down from a cash perspective? It’s that critical financial statement that then lands to that further understanding of what is your cash position? What does it look like both short-term and long-term? I hope I explained that. The balance sheet is hard.
It is a hard thing. Sometimes, I consider that as an accounting parking lot. It’s where you put things that haven’t been yet applied to some degree.
It can become the graveyard and that’s where you have to be careful. You need to know what is on your balance sheet, why is it there, and does it still belong there? I always say that that’s where you bury all the bodies because your balance sheet rolls forward year-over-year. It doesn’t clear out. Anything that you’ve put on your balance sheet on accident sits there and haunt you forever and tell someone goes in and cleans it up. You need to look at it on a monthly basis, make sure that you know what’s in each account, that it’s real and right.
That’s the difference between a lot of times what the bookkeepers do, what controllers and the higher-level strategic accountants do is they make sure that there are no buried bodies on your balance sheet. Your balance sheet can also misstate your forecast of cash. If you’ve got a body in there that you don’t know is in there and all of a sudden it comes out, you could either have a surplus of cash that you didn’t know when fall yet or you could not have as much cash as you thought. For example, inventory.
It’s the latter, not the former. I would also say in general, to everybody reading, please make me a promise. In this industry, regardless of which of the topics we’re covering on a podcast like this, we talk about things daily that almost become pedestrian. They become normalized including things like balance sheet, statement of cashflows, and various ratios. I know because I was there and I’m still there. There are many of these things that we shake our heads and pretend that we understand.
One of the things that you should always do when you’re working with an advisor or service provider, whomever, is be vulnerable enough to ask them to clarify or educate you about a specific element of what they’re doing or what you’re looking at so that you increase your knowledge base and become a more critical consumer. There’s no shame in it. There’s nobody, no one. I’ve been doing this for many years and I still spend far more of my life and my time as a student than I do as a teacher.
There’s nobody who knows every element of it and you should never be reticent to ask the question and say, “Can you stop and explain to me what this is? Can you tell me what I’m looking at?” Especially with something that’s fundamentally important as your numbers and your financials. I want to encourage everyone to do that. Last question before I get your contact information and all of those normal pleasantries out of the way. Brands are going out to raise whether they’re raising convertible notes or doing price rounds, meeting with Angels all the way up to institutional investors, what should they know they have ready in their suite of financial information? What should they be versed in to be able to explain and speak to?
The most important thing a lot of times is revenue. How are you forecasting your revenue? How does that lead you to where you think you’re going in your financial forecast, your P&L, your forecast? They’re going to zone in on that. Are you going eCom? Are you going brick and mortar? How are you going to accomplish that? The second thing that they want to know is what is your margin? Trade spend that we talked about. Them understanding how much money you’re investing in your growth is going to be important. They want to understand that your margin is large enough. What I mean by margin is there are 99 different ways you can look at the margin. I call it manufacturing margin which is before you add on trade spend, what is your margin to produce your good based on your sales price?
How much percentage do you have leftover to utilize in other ways? They want to make sure that you have a strong manufacturing margin so that you can weather trade spend and still have plenty of money to invest below the line, selling costs, marketing costs and back office. That’s where it comes back to having that forecast because you’re going to walk through all of those baseline assumptions and be armed and ready. Those are going to drive to the end number which is how much am I asking for? How much you’re asking for is going to discern what type of investment that you are asking for whether it’s a convertible note or an equity round. Putting thought into how you’re raising revenue.
How are you going to support that revenue with sales and marketing efforts? What is your manufacturing margin? That’s the questions you’re going through to create your baseline assumptions on your P&L, on your forecast to financials at least two years out so that you know what your cash ask is. Don’t start hunting for investors prior to knowing those things. If you switch on them because you put the thought in afterward, that’s the quickest way to shut those conversations down. Put your due diligence in on the frontend before you go out and start sourcing funds and know what those numbers are because those are the first three questions that they ask. That puts you in a nice cadence of forecasting and thought processes strategically about your business.
The only thing I’d add to it is that when you’re ready before you meet with investors, sit down with whomever you’re working with on your numbers or with an advisor and hand them your financial packet and say, “Ask me the questions.” The investor is likely to ask me, help me work through the answers, and help me understand these numbers. Be the most educated student of your own numbers before you ever meet with an investor or before they ever go into your data room and start looking at your information.
If you don’t ask the people around you to help you become conversant in them, that’s the thing that investors look for too. These numbers aren’t disconnected from you and you’re not disconnected from them. You are as much an author of them as you are as the person doing the actual books or strategic accounting is. This was awesome. We’re out of time, we can talk about this a lot. Hopefully, we put a lot of people to sleep as well. We’ve done a double duty here. If people want to learn more about AVL Growth Partners and you, what’s the best way, Heidi?
The best way is you can email me at HHuntington@AVLGrowth.com or you can go out to our website, AVL Growth Partners, and learn all about the different industries we work with and more about what we do in the different brands we’ve worked with. Anyone can reach out to me and email at any time even if it’s for basic questions. I’m more than happy to share some knowledge and keep things going for you. It was such a pleasure to be on. I appreciate you having me.
It’s my pleasure. Thanks for taking the time. Everybody, thank you. I hope you get some valuable insight from this. I look forward to seeing you soon on another episode.
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