Building a Solid Accounting Foundation for MSPs

Building a Solid Accounting Foundation for MSPs

Baxter: [00:00:00] Well, listen everybody, um, we couldn’t be more excited to be kicking off this community initiative.

Um, this initiative is really all about community. Um, it’s all about, you know, You know, providing a much better experience for MSPs and giving back and ultimately helping you all run more successful businesses. As a quick background, we started Alternative Payments four years ago to help build a better financial future for MSPs.

We started with payments and accounts receivable, but we’re building something much larger and our team could not be more excited. This MSP Office Hours series is really an extension of our company’s goals to drive financial outcomes. For MSPs, but not just through product, you know, again, really through knowledge sharing, ideation, and this entire feedback loop.

Accounting and finance are always two areas that it’s amazing, you know, always come up as really major challenges. And so we [00:01:00] really couldn’t be more excited to kick this off with Paul McCann. I’ve gotten to know, and the company’s gotten to know Paul for the last few years, We’ve developed a great relationship, um, really, I would say, because we view the world in a similar way.

Uh, we really are focused on targeting outcomes for all of our clients and customers, uh, not just, you know, selling snake oil. Um, but without further ado, I’ll turn it over to Paul McCann, and excited for you to, to dig in. You know, please, please, please, if you have any questions that come up in the middle, you know, don’t hesitate to, um, send in anything over Q& A.

We’ll be monitoring all of that and want to make this as conversational as it can be to ultimately, again, drive insights, drive knowledge, drive community for all of you. So, without further ado, Paul, take it away.

Paul: Hey, well, thank you very much, Baxter and Steve. Exciting to be here with you guys. Uh, thank you for showing [00:02:00] up.

Uh, I will say I’m a little surprised, uh, that this many people have shown up about, uh, talking about accounting. And I will try to keep you guys awake, uh, the whole time. That’s my, that’s my personal goal here. And I, and I won’t say anything about the fifth inning of the World Series last night. So we’ll, we’ll keep everybody, keep it on the

Baxter: up and up.

Um, accounting is fun. Accounting

Paul: is fun. Well. Yeah, the, uh, so a little bit about me. I’m a, I’m a CPA. So I, uh, um, I started Red Earth CPA about, uh, right at seven years ago, and I knew that, that a few things About where I was going and where it come from. Uh, I’d been in a tax practice, I’ve been in a large CPA firm, um, spent some time in a few different backgrounds, but really what defined more of, of, uh, where I was coming from is my, [00:03:00] my wife and I lived down in South America for four years and we, I was a microfinance specialist and that meant that’s a very fancy way of saying that I went around and formed savings groups with the organization that I worked with and.

Through those savings groups, people were lending to each other. And I would teach a, uh, educational, uh, a course, an educational appropriate business course to local entrepreneurs in, uh, the Amazon Jungle Basin of Peru, uh, town co called Alpa. So people often wonder where RedEarth CPA came from. RedEarth is a play on that relationship there between Pucallpa, which is a Quechua word which means red earth or red dirt.

Uh, and so I ended up naming, uh, naming my firm seven years ago, or when I, when I started, I ended up naming it. It’s a tribute back to that time. So, uh, I’ve, I’ve [00:04:00] spent a few different times. So there’s a really a more of a transformative time in my life as I I worked with some people who were, uh, some entrepreneurs who were down to, uh, about a dollar $52 on average a day earnings and, and creating a system there.

And it was a lot of fun. I mean, it was really a, it was extremely difficult. Um, fun is probably not the word I would use to describe most of the time, but at the, at the end of it, it was, uh, we started. I think we ended up starting 14 savings groups that had saved, uh, you know, thousands and thousands of dollars and had, you know, just great results for their members.

And As I looked at how to start or what kind of firm that I wanted to start, I wanted to be highly valuable to the people that we serve and looking for the outcomes, as Baxter mentioned, making sure that we’re trying to drive success in a very particular way for our customers. [00:05:00] So that’s, that’s really kind of the principles, some of the, some of the ideas behind it.

As Baxter and I was talking about where, where we like to go and, and what we’re, what we’re about. It’s, uh, I don’t view accounting, one of the reasons I don’t talk that much about accounting is one, I do want to keep you awake, but second of all, uh, accounting is not about really, it’s really not accounting.

The way I view accounting is. is can we get your company to be successful? And what is standing in the way of doing that? Accounting is one of the, the accounting and finance portion of your business is one of the, what I would call the three legs of your, your stool, which, um, or the, the, the proverbial business stool where you have accounting, finance, operations, and marketing and sales.

And as I have, as I’ve worked with MSPs. You don’t go into [00:06:00] business to be in accounting, the entrepreneur does not go into business to study their financials or to balance debits and credits and reconcile bank accounts. That is the absolute opposite of most entrepreneurs or what they want to do. And as I wanted to start a firm that was, as we’ve started a firm, our firm is about empowering success.

Uh, and moving people along that, strengthening that area of the business so it can move away from having a job to having a business and, and these systems then are, are supporting your sustainable growth of the entrepreneur. Um, I want to talk also about the, um, accounting is, is it does, the word is just, um, is boring, right?

It, it, it is, it is a boring phrase and it [00:07:00] is, uh, I once had somebody say, aren’t you, aren’t you concerned when I said, well, something wasn’t cool. And she goes, well, wouldn’t, aren’t you concerned that that’s not very cool? I said, well, at the point where you go into studying a CPA, you realize that you’re just not going to be very cool.

And that’s, and that’s it. And I say that I joke about that, but the purpose of a system in your business is about setting up a boring system that can operate and it can function. Over and over in a consistent manner. And that’s, that’s really what, when I refer to accounting, I refer to it as, you know, let’s, let’s make it boring.

Let’s make it repeatable. Let’s move it away from the amygdala portion of your head. Let’s move it back to the area that is a routine and it’s process. And nobody has amygdala hijacking. At work. Uh, so boring, uh, Atomic Habits, James Clear writes, he tells a story in [00:08:00] his book about a, an Olympic, uh, weightlifter coming into his gym.

And, and he talked a little bit about how, uh, just like what’s the psychology of somebody who’s an Olympic level weightlifter and the person who was training him made this comment that I’m sure many of you will have read the book. Uh, but they said, he says that a lot of, uh. Amazing lifters will give up before, um, before they get to that level.

And it’s because they’re not willing to do the hard work, the repeated work that is over and over, and they just get, they just get bored. They get bored with the workouts and they, they, they don’t, they don’t succeed because it, they just get timed out basically.

Baxter: And also Paul, I think you’re right. It’s about creating that structure, creating that repetitive motion that ultimately unlocks insights.[00:09:00]

And then allows the business owner, right, or the technical leader of an MSP to then say, all right, well, I’m going to allocate this precious time that I have, this precious resource into the most high ROI seeking event, right? And so I think what’s, what’s special about accounting, especially in the MSP market, is accounting’s really, really freaking complicated for MSPs, but if you can get it down.

And you can really understand what’s the gross profit of this piece of hardware, or this license, or this, you know, managed service, whatever it may be. Then you know how to allocate your resources or your team’s time appropriately, and then hopefully bring in, you know, a lot more of that, right? It’s like, no different than, hey, I really like cheeseburgers over pizza, and so I eat more cheeseburgers.

Um, it sounds like a really stupid analogy. But if I know that [00:10:00] cheeseburgers give me happiness as Baxterlanius, then I’m going to seek out cheeseburgers. And if you know that managed services for this type of ICP client brings in a higher profitability and you can bring in those clients because that’s what fundamentally the books and records show, then, you know, you got to go find that, that MSP business or that cheeseburger.

I don’t know why I just came up with that analogy, but hopefully it hits.

Steve: Are you hungry?

Baxter: Maybe, maybe it’s, you know, after the Yankees loss, I’m looking for a few beers and a few cheeseburgers in New York here.

Paul: That’s funny. That’s funny. Well, I mean, exactly. Uh, Baxter, as you’re, as you’re talking about it, I mean, I’m, I’m thinking about the people that, that we work with and their starting point is, you know, one of the entry level questions or intro questions is, you know, what, what’s making you money?

Like, Oh, I’m, I’m excited about this Yeah. My net margin, well, but which one is it? I [00:11:00] mean, as you mentioned, the, the whole approach of, of accounting and, and MSPs, like, well, what, I’m a big fan of, uh, service leadership. I do, uh, hop on every webinar I possibly can and, uh, study their stuff. There are so many different service lines that people are offering.

And trying to identify exactly what service you’re offering and what’s your profitability, each one, your, your MSP versus a VAR versus any other, uh, component is going to be completely different. So, uh, yeah, I mean, this is kind of getting ahead of it, but people are. You know, they always want to know what the valuation, like what, what’s the valuation of my MSP?

What, what are you selling? Like let’s work backwards on that. Let’s, let’s figure out, are you selling a service at the right price or are you earning as much money out of it? But you don’t know if you’re, you don’t know where you’re at until you’ve done the hard work and it all boils, it all [00:12:00] just flows back down to the nuts and bolts of, of, uh, of accounting.

Baxter: Awesome.

Paul: So this is a, uh, it’s about the foundation. Right. The, uh, what I, what I would,

I don’t want to bore you, but expense categorization and, and it is really, uh, it is really the, the blocking and tackling of putting the gross, uh, putting together a, a really well done gross margin. You know, do you have a really good idea of what your gross margin is? Uh, are you charging enough for your tax?

And do you have, uh, do you have your client facing wages as a cost of goods sold? And can you put that all together? And that, I just put it as an expense categorization. That’s a, [00:13:00] an allocation of, that’s where I see one of the biggest challenges that people That people come in, it will say, I want to know where, where I’m at with this, but mapping out your chart of accounts and mapping out your vendors and saying, this is where this expense goes, or this vendor, and this is the service line, and that is Uh, getting to the point where you can look at a revenue item and a cost of goods sold and have a really good idea of where your margin is.

And those, those questions, because people, Baxter, I’m sure you’ve, you’ve run into it, but the, the really cool questions are, you know, how much, how much is my MSP worth and how much can I exit for and how, you know, how, how can I do this? You know, I, I heard about this other guy that they were doing great.

Is mine worth the same amount as his? And, uh, Those are fun questions, and I get those questions quite a bit, and it’s fun to sit around the M& [00:14:00] A and listen to people talk. I’m going to be at ITNation next week, and I always love to grab a couple talks listening to where they’re at. But it’s almost like you’re getting a cart in front of the horse on these things.

You really need to figure out where If you can’t understand your financial statements right now, if they’re not really, really easy to understand, then, then all of those are kind of secondary and you can’t get to them.

Baxter: Are there any templates or structures, um, or documentation that, you know, call it our best practices for the categorization?

Cause I totally agree with you. Like expense categorization is absolutely critical because then it allows you to understand trends, right? Month to month, quarterly trends, annual trends. My product line, you know, by tech, for instance, and you can pin down on those fundamentals to then [00:15:00] ultimately generate insights, which then allow you to kind of have the maybe more fun conversations.

And that’s, I think, a little bit of the journey. But what are there, are there resources that, you know, MSPs typically can lean on to really pin down that expense categorization?

Paul: Yes, um, so the gold standard was the, the chart of accounts from service, service leadership. And the first time I, I downloaded that several years ago and was looking through that, I was like, well, where’s the, where’s the bottom of the chart of accounts here?

I, it’s, you know, five pages long. It’s got every, every bit of detail and people’s eyes just kind of roll back in their head as the level of detail. It really is the gold standard. But even those guys will say, we put everything in there, but that doesn’t necessarily apply to every business. So, it’s a great starting point, and they do a fantastic job of organizing, uh, those, those expenses, and that’s, that’s a great place to start.

Uh, people [00:16:00] seem to take that and pare it back quite a bit. ConnectWise has their, um, has their own as well. They will They’ll steer people. I see some people who have, who have done a really nice job of putting those together when they started out working with their ConnectWise consultant years and years ago, and, uh, and putting those in a format.

There are variations of those, but those are the ones that I hear about quite a bit.

Steve: So I, I have two questions. One, um, Let’s define gross margin for some of the people on the call that may not know what that is.

Paul: Okay. The gross margin is, uh, yeah, well, we got to get in the cost of sales there too. Uh, so you have your revenue,

Baxter: everything that comes

Paul: in your business and then everything that’s sold to your customers.

So once you take all the money that comes in and you subtract everything that’s sold to your customers, That’s your gross margin. So that is, um, what it, I [00:17:00] guess it probably in an MSP, most, most expenses that go out the door are in your, your gross, you know, you keep your sales general and administrative costs down in the bottom.

Uh, your rent will not be in that. Your, uh, your salespeople and some of the software you use internally. But for the most part,

Steve: So the PSA arguably could be an expense or a cost of goods sold, depending on how granular you want to get with that. That’s a

Paul: great question. That’s a great question.

Baxter: I would say it’s a cost of goods sold, right?

And you need your PSA to service your client and your gross margin is basically post servicing of that revenue. Um, is, is. Typically, I think the way they think about it in the MSP world and also other industries, operating expenses are always going to be incremental to the business at the end of the day.

Um, so ultimately as [00:18:00] an MSP grows, like the CEO’s salary could not be servicing the underlying client, right? Their time should be allocated to much more strategic operations, much more growth. Orientation selling for net new clients. And so you’d, you know, CEO salary typically would be an operating expense.

Um, but again, you know, a lot of it depends on size of MSP and, and accounting. Um, Procedures.

Steve: Okay, um, that, that is interesting because, uh, Degley is of the same mindset as me that I always thought of the PSA as like a, uh, an operating cost or an administrative expense, um, because I don’t necessarily Deliver the PSA to the customer I guess was where my mind went and because I’m not delivering the PSA to the customer I’m using it internally for [00:19:00] ticketing and and invoicing and that type of stuff.

I always thought of it as a I don’t know As just another expense. It

Baxter: depends on which PSA you’re using and how you’re using it, right?

Paul: And Steve, those are, those are good questions. Uh, I think one of the, one of the aspects about this is there is a, there’s kind of a, ServiceLegion has a, I, I, sorry, I’m saying their, their name too many times, but they, they really have put together a, a platform when you get into their, That it says this is this is how it works.

The advantage of that, and they would put it in, they would put it in a managed service, uh, gross, and they would Uh, cost of goods sold. And the, the advantage of that is when you go to compare your books with somebody else, or when you go to put it in a model and when you get to put your evaluation, everything’s lined up.

So the, the approach then is apples to apples on all of your expenses. And that’s, [00:20:00] that’s really the value that they, that one of the particular values that they drive is, you know, these. These questions are like, well, I’ve done it this way and I’ve done it that way. Well, there is, there is a, a standard out there that these guys have put together.

And if you’re speaking the right language, you get your financials and Beachbody shape, uh, all the, all the time. And, and then you can talk apples to apples on that.

Baxter: Yeah. And I think Barack had an interesting point, right? A CEO salary is a labor cogs, in my opinion. It all depends on how much time the CEO is allocating to direct labor, right?

If the CEO is allocating time to the clients to fulfill that revenue, then certainly the CEO’s salary should be in cost of goods sold. I’m just looking, I shared a PDF for the service leadership information chart of accounts. And on page 21, you know, just as a reference, um, there’s direct labor, direct labor wages, [00:21:00] COGS.

This COGS line item is designed to capture the wages, expense, salary, plus any bonus, plus commissions of the technical professionals employed by your company that are providing delivery of the service. So again, you know, if you’re a CEO and you’re delivering a service, then certainly that allocation of time.

You know, would fit into Cost of Goods Sold.

Paul: And at the level of clients that we’re normally working with, we’re not, you know, the CEO of a company with 5 million in revenue is not the same as CEO with 50 million in revenue. And what, what the best practice is to say, well, 30 percent of my time is going to sales.

40 percent of my time is management and the rest is going to whatever else. And you’re going to divide that out. That’s going to give you a truer picture of where your margin is, even though it’s the same person’s W 2.

Baxter: And then, you know, there’s, there’s, there’s the other thing that makes, I think, a [00:22:00] challenging, um, for everybody is like, there’s a fair amount of gamesmanship, right?

That goes on, right? I don’t want to allocate. You can’t have this about the accounting conversation, it’s all black and white, it’s all black and white. Like gamesmanship of, you know, do you, do you want to show higher gross margins, right? Do you want to show lower EBITDA margins? Why or why not? Are you preparing for an M& A transaction?

Um, you know, are you preparing for your tax filings? Do you allocate expenses, personal expenses, to your P& L? Um, you know, there are all sorts of gamesmanship that make it, you know, especially challenging to then put these income statements, cash flow statements, balance sheets, side by side. For any business, um, to, to manage and monitor.

Paul: One of the best games on the ship is owner [00:23:00] compensation. And, you know, hey, I get to choose how much money I make. I’m not going to make anything. I’m gonna make a whole lot more money. I’ll just pull it out as an equity. Well, you know, the IRS doesn’t like that. Benchmarking doesn’t work very well that way either.

Baxter: All right, shall we go into, sorry Steve, go for it.

Steve: No, I was just gonna say, and we could get into the weeds all day long about what should be COGS versus what should be an expense when it comes to people, um, I do want to ask one more. Inez asked what your thoughts are on account managers or service managers, like the supervisors, um, would those, would those be COGS in your opinion or?

That’s the last one I want to talk about there is for the cog stuff. Um,

Baxter: ley, you’re only making one buck an hour, man. You got a year. You gotta gotta up that salary.

Paul: You know, I, I feel like there’s a right answer to that and I, I wanna look that up because, uh, that is, that is one of the most common [00:24:00] questions, the, uh, that I, I wanna, I wanna look that up before I answer.

How about that?

Steve: That’s fair.

Paul: Well, well, Baxter, the next portion here is, uh, you know, as we look at accounting, I kind of start with the nucleus of our general ledger and then look out from there. How do we get payroll to work really well? How do we get AP to work really well? And how do we get AR? And I know that’s near and dear, uh, to your, to your heart as well of getting accounts receivable to be an asset of the business and not something that’s just an expense.

Baxter: And I think, Paul, two and three are copied here. I think, what’s three supposed to be?

Paul: Oh, yep. There we go.

The, uh,

Baxter: yeah. One’s AR. Yeah,

Paul: it was, uh, looks like that just came through. Yep. Um, we’ll just skip that one. No, it was, it was the, the AR function of getting that, uh, [00:25:00] figured out as far as, as the workflow is concerned. I mean, people, I mean, I still hear, I still see, see a lot of checks, you know, people are still, still getting a lot of checks and taking those and, and at, you know, worst case, still driving them to a check or a bank, but that does still happen.

And we always encourage our people to, to do as much as they can to automate that.

Baxter: Yeah. I mean, I think that the, the job’s not done when the services are provided. And I think that’s really kind of one of the biggest misconceptions and challenges that you know, we see a lot where you know Hey, you’re providing an A plus service like, you know, your service could be absolutely best in class But but how do you get paid for that service?

And and and how do you get paid quickly for that service? Steve and I did an interesting I guess recording the other day around networking capital, you know, if you can get all of your [00:26:00] money On November 1st, let’s say, and then pay all of your vendors on November 30th or December 31st, you know, that’s a tremendous amount of additional capital you have to reinvest in your business.

And payment processing and payment automation and accounts receivable automation is all just about how do you get more money up front, and then you can delay your vendors a little bit to allow you to accelerate or optimize cashflow in your business. To then reinvest. Um, but you know, again, it’s a, it’s a, it’s an important piece of the puzzle, but I think categorizing your expenses and making sure that that platform is built sustainable.

sustainably is, is also, you know, critical.

Paul: Well, I mean, what you’re bringing up there, Baxter, is, is there, what we see quite a bit is clients hit a big growth curve and then they run out of cash. You’re like, well, how, how’d I run out of cash? Cause I just sold all this work. Well, you have to, [00:27:00] you have to get, you know, a lot of these people are bootstrapping.

Uh, they’re, they’re, they’re growing it and you’re relying on the cash that your customer is providing you to be able to provide the services. So the faster, I mean, just. And I think that’s really, you know, as simple as possible, the faster you get that money in and as you collect that, you can turn around and so you don’t have that pain of running out of money between, uh, while you’re growing.

Baxter: Totally right. And I think it’s a good segue into, you know, what’s the value of long term, uh, investing and accounting, right. Which is really around, you know, point, the left point or point one and point three. Um, you know, solid financials allow you to prepare for financing, prepare for M& A, expand, and then point three right around.

Continued acceleration, but I’ll let you, I’ll let you hit on .

Paul: Yeah, no, I mean, I don’t wanna, um, spend too long on this, but [00:28:00] expansion, financing, expansion, I, I, I talk about Beachbody, uh, Beachbody financials, and I, I want, uh, had a conversation.

Baxter: But you don’t live near the beach?

Paul: No, no. I don’t live anywhere close to the beach.

The beach body. The idea though, Baxter, is that at any point in time you can give your financial statements. To a third party, and it would be accurately reflecting the nature of your business. So just as somebody who lives close to the beach goes down to the beach and they take their clothes off to sunbathe and go swimming, you know, the idea is that most people don’t see their financial statements, but you’re living in this, this.

Continual state of being willing and able to hand your financial statements to a potential financial partner, be it banker, private equity, uh, somebody who is looking at buying your company, you know, getting that, that’s a, that’s a big lift for a lot of companies and they would have to spend thousands of dollars just to get their financials in a place.

Where they can’t even have that [00:29:00] conversation.

Baxter: What on that note, Paul, what, what do you, what, what are best practices in terms of like getting your financials there? Is it monthly closes, quarterly closes, annual closes?

Paul: Yeah. Um, monthly close, best practices, monthly close. We see some people who are, well, probably a few on this call that we talked to you recently, but you know, usually people have a day of the month, the best practice, they have a day of the month and everyone knows what the expectation is on closing the, uh, the books by that month, by that day, excuse me.

That is, that’s, that’s what we see is, is a well run, a well run company that has, you Just getting that flywheel going and then closing things out on a certain given day. I know some people who do it by the 5th. That’s pretty aggressive. Uh, 10th is a little more attainable if you have dedicated staff.

Those are easier things, but, but really it’s about setting [00:30:00] expectations and following through on those.

Baxter: Yeah. I think our alternative payments as books are closed. I think they’re supposed to be closed on the 20th. We have an outside accountant, not Paul, it’s not Paul, not yet, um, uh, who closes our books on, I think, technically, like, typically the 30th.

We probably do, like, one or two iterations of comments, and so our process is a little bit slower than I would like, but, you know, it’s not, it’s not always easy to, you know, keep things as tight, uh, 15 day close. And,

Paul: and that’s still, if I could get most, most people having a close, I mean, some people live in a perpetual state of openness too, so, uh, that, that doesn’t really get you where you want to go or your, you know, your loan has not been tied out between, or split out between principal and interest until December, and then you go to do tax planning and all of a sudden, wait a second, how did I make so much money?

Well, you know, if [00:31:00] you don’t split these things out throughout the year, and, and, and, and And I know, um, I know I’m only talking to one person on this call, but, uh, that, that is one of those pain points that, you know, you can’t get into it’s so I put the audit ready and minimize. I don’t like, um, uh, I don’t like scaring people going, Oh, the big bad IRS is out there, your state auditors.

That’s a reality, but it’s a reality just like, um, cybersecurity is a reality when you’re talking to your clients, right? Like, I don’t like to camp out on that. That’s not the. But, uh, I like to go to the carrot, the carrot of keeping things looking really good all the time. Um, going to the gym, you’re working out, you’re staying active, and you have the results to show for that.

Steve: One thing I want to, real quick, um, I want to launch a poll, just to see where everyone’s at today. Um, so if you guys could take a, it should take you a minute, it’s [00:32:00] all multiple people. There’s only 57, I’m kidding, there’s like 5 questions. Um, but while you guys answer that, I want to talk for a minute about, you said something you were talking to one person, I’m that person, Paul.

What do you mean splitting your loan between principal and interest?

Paul: Thank you. Thank you for that question. I need to make sure I So, every loan payment, if And it usually doesn’t take, um, it’s a discipline, right? So getting as part of the monthly close, you would spend, you would send in your, maybe your SBA, uh, loan that you used to buy the business, or you will, uh, send that amount into your bank servicer.

And as a portion of that amount, a portion of that is interest and a portion of that is principal. Now you’re like, oh, well that’s, that’s. Everybody knows that, right? Well, or some people will think that [00:33:00] if you don’t do that, however, and if you don’t put your principal portion, your principal portion is not deductible.

So what at certain levels, and some people will do is they’ll say, I have a 2, 000 a month payment, 2, 000 a month, it just goes to interest expense. Well, when you adjust the books, if you do it only once a year or twice a year, that portion, you end up having the principal portion of it is picked up on your profit loss as income.

And there can be a wild swing that people just, just aren’t paying attention to, um, for, for lack of better reason. And they get to, let’s see, we’re at the end of October today, so tax planning really starts in earnest at the end of November, end of December. And they go in and they talk about tax planning and they say, how, how did I make so much money?

How did, how, how in the world did that happen? And it, and it’s, it’s a, it’s a consequence of not having the process set up [00:34:00] and continuing to do that on a regular basis.

Baxter: What do you, what do you think, Paul, are like the, the catch 22s for typical MSPs, like three to four? Is it miscategorization of principle and interest?

Is it. You know, what are the kind of like the high level buckets? The biggest

Paul: pain, but let me strumming, uh, strumming my pain. Like what

Baxter: should people watch out for? Right. I mean, you know, some, I’m sure people on this call, some people do their own accounting, I’m sure some people have outsourced accountants, like what are the, you know, quick three items?

Like, Hey, these are going to have big impacts on your books and records. Like next time you meet with your accountant, you know, let’s, let’s just ask them about these three items.

Paul: Oh, one of the things we ask people about and. Most, most people have a pretty good idea of, of whether or not they’re paying taxes on the accrual basis to the cash basis.

And that, that, I, I know, I, you can, you can roll your eyes on it, but, [00:35:00] but if you toggle back, I mean, if you, well, I, I don’t know, I thought, I thought you were like, well, come on, everybody

Baxter: should know that. No, no, it’s complicated. It’s accrual.

Paul: And if you’re in, if you’re in a software that can go back and forth between the cash to account, I mean, if you hang out with.

The MSP industry is all about accrual accounting because that’s, that’s the way it should be, right? You’re, you’re sending an invoice and you’re receiving payment. However, my clients don’t want to pay taxes on Invoices they’ve sent, or they’ll wait until January 1 to send them, uh, because that’s just not, they just don’t like paying taxes on money they have not yet received.

And so for that reason, and many others, people go to the cash basis. So I would say back sort of to answer your question, one of the first things that, you know, are we. Are we tracking it in the right format? So even though you go through the entire year on the accrual basis and you’re doing, you know, we do benchmarking on the accrual basis and we do, um, we, we will, we will count the income when we send those receipts and count the [00:36:00] expenses when we receive the, the bills.

But you only pay, you don’t pay taxes on that. So if, if I were, if I were to answer that question, I would say, make sure if, if you are paying on the cash and running your business on the accrual, make sure those adjustments are being made. And you understand that you’re not paying taxes on the accrual.

And, you know, if you’re, if you’re going back and forth there, we have a client who’s probably on this call and we have gone back and forth and back and forth with their previous accountant because. Something couldn’t be, it was just very complicated and very difficult to do. So that, right. And so

Baxter: I guess, Paul, the risk, right, is if you’re accounting on the accrual basis, you could potentially be significantly overpaying or significantly overpaying

Paul: for, well, sometimes people are, are losing money on the accrual and making money on the cash or vice versa.

So it can completely swing your perception of where you’re at. If, if you’re not understanding, [00:37:00] ideally you’re wildly profitable on both. That’s where we all want to be, but that’s not necessarily if, if you’re on the accrual basis and you go out to one of these vendors that I won’t name that you have to get a, you know, you got to go to their website, you got to go to their portal, you got to download and you missed a couple invoices.

And let’s say it’s from June now. If you forgot a bill of theirs and you enter that into your accounting software and you’re on the accrual basis, that, that impacted your profitability on the accrual. And it happens, we see it quite a bit, but those are the, those missed invoices, they throw off your profitability, whether or not you’re actually paying them right now.

Baxter: Yeah. Or another great example, right, is just for, uh, for services provided, right? So you provide services, you book revenue, But actually, those services are sitting in accounts receivable, which is not cash. Uh, [00:38:00] and, you know, I think you see this a lot, right? For an accrual basis, your books look good, but because you’re not getting paid in 30, days, on a cash basis, you’re not bringing in that revenue.

Um, which is, uh, so what about number, number two or three?

Paul: Uh, the pain point of whether or not it’s Beachbody ready, is that what we’re, is that we’re going for? I would say sales taxes is one of the biggest challenges. It is just, it is a constant battle about how to best manage sales tax. What’s taxable?

What’s not? Where are you shipping that to? Does that, am I, I, I live in this state, therefore I’m going to pay taxes in this state. Well, that’s not necessarily how it works. And whether or not, if you’re invoicing out of your PSA, if you’re invoicing out of your accounting. file, those, um, you know, do you have Nexus in that state?

Is that your first, you know, did you, did you cross the threshold? Did you cross the number of transactions to, to generate [00:39:00] Nexus? Or do you, are you telling your customer that they are supposed to pay use taxes on that? Those are, those are, um, really challenging questions and conversations.

Baxter: This is a, this is a great question from Degley, and I don’t know the answer to it, uh, Paul, so I’m gonna, I’m gonna lean on you, um, as the resident expert.

Uh, what about when your state requires you to pay taxes on a accrual basis and not cash basis?

Paul: Yeah. Yeah, that, that sales tax is a great example of that. Um, many, many states will require, require the sales tax on the accrual basis. And then there’s this back and forth of like, well, how in the world am I supposed to manage this on the accrual when, when I’m paying on the, on the cash?

And those are the, you know, hope you get it, you get a software package that can manage the two of those. And, um, There is unfortunately some negative numbers that show up on the balance sheet, if you’re toggling back and forth between the two of them, because you prepaid [00:40:00] essentially, if you’re doing it on the accrual.

Baxter: What’s a good resource software product that helps, helps folks manage that?

Paul: I don’t know. There’s a couple of them out there that will do that. And it really depends on, you know, there definitely, there definitely are. I don’t, I don’t want to, I’m sure everybody’s thinking of, of one or two. There, there are.

Jeez.

Baxter: Is Avalara one?

Paul: Yeah, Avalara’s one. They’re, they’re the biggest ones. And hey, they will plug in right to the PSA. And there’s another one, TaxJar, that does that as well. I think

Baxter: TaxJar just got acquired by Scribe.

Paul: Oh, I think I did see that. Um, so those are, those are a couple when, when we see people who are going rapid growth and they’re going multiple States and they’re, and they’re really building it out, you know, that’s the recommendation, Hey, if you’re looking at, if you really want to get sales, sales taxes, so painful, I tell people all the time that, that there’s no way you’re doing it a hundred percent, right?

I mean, it’s, [00:41:00] it’s, it’s so difficult. And one of the things I wrote recently, um, on our blog about sales taxes, these are updated. Many, many states are updated July 1. Well, you know, who’s, who’s thinking about updating your sales tax in your PSA or in your accounting file at July 1, if you’re out selling, or if you’re at the barbecue and you’re, you’re in summer mode, that’s just not something people are thinking about.

So if you really want it to be perfect, I think where you are, you are contracting with a company, a sales tax software that does it. Straight, you know, from the very beginning, invoicing all the way through payment. Can

Baxter: we move to the next slide and then open it up for questions? Yep. I think there’s also

Steve: Someone said, someone said Avalara, Avalara is great for multi state, 1099, and integrates with many systems. They can even file for you. Where the issues can lie [00:42:00] with the filing is that someone needs to scrub the sales tax for accuracy.

Paul: Good, uh, good feedback there. Thank you. That was good. Um, so it’s really, really where we’re going. Like, we’re going to the summit, we’re taking these companies, you’re taking your company to the summit. How do you get from the trenches of the day to day accounting where you really want to go to My company is worth this much.

I have my financials ready. I understand my processes. I’m not living in the accounting file as an owner of the business. Somebody else is doing that. They have a system. It’s not different. I think the The main takeaway here is where I would want to leave it is don’t think of it different than any other aspect of your business.

You know, a lot of, uh, a lot of businesses are focused on sales and marketing as fast growing. Well, that’s great. And a lot of owners come from the production standpoint, [00:43:00] but that of that third area where the finance and accounting, if your company’s going to grow and it’s going to scale at a. At a larger size, then you, you have to invest and really think of it as an investing to get to the scales, the portion of your business and the summit portion of your business, you really want to invest and it’s high ROI stuff.

It can be really very high ROI, uh, investments made.

Baxter: I mean, it can seem like really low ROI.

Paul: Well, yeah. I mean, it’s, you know, it’s

Baxter: an incremental cost, right? I mean, I, it’s funny. I mean, I, you know, I’m a business, I’m a business owner and, and we have an outsourced accountant. And, you know, I would say that we’re, we probably spend, I think our business spends 2, 800 a month, which is actually quite low, given the size of our business and we have, we now have 35 employees across three countries, Canada, the U S and Brazil.[00:44:00]

Um, now, we use payroll software and systems to manage payroll effectively, uh, but like, you know, similar to an MSP, we have many different forms of revenue. We have a subscription fee, we have transaction fees, credit cards, uh, we have lending revenue that comes in, accrual base, you know, we have interest expense tied to that lending revenue that we pay to a separate party, um, our books and records are not, not seamless, uh.

And the question that I always have for our team that’s more involved on the day to day kind of monthly, month end close is like, you know, are we doing everything we can and should be doing in terms of getting those insights to then make decisions, right? And, and that’s where my head is strategically in this kind of CEO seat, but it’s, um, it’s a tough, it’s always a tough pill and question to swallow, I think, from a business owner.

You know, what’s the right amount? Is it 3, [00:45:00] 500 a month? Is it 4, 000? Is it 5, 000 a month? Is it 10, 000 a month? And what are you going to get for it? And how can it improve your business and improve these growth areas? Um, you know, I think the, for me personally, um, you know, and would love to open it up for Q& A as well.

You know, the takeaways are one, you know, that system and structure and GL chart of accounts is like, Day one, right? Like what’s the most important piece here is categorizing expenses, revenue, very, very clearly. Now, where do you want to allocate those and costs of goods or operating expenses? You know, there’s obviously some gamesmanship and it’s a little bit of art, not science.

Um, but when you have that structurally in place, there’s obviously systematic processes and improvements that one can make in terms of closing their books faster. That’s You know, getting ready for taxes, et cetera. [00:46:00] Uh, but then, you know, I think you kind of nip it, uh, hit the nail on the head in terms of, well, what’s most exciting, right?

Because once you have that platform built, once you’re able to close the books on a monthly basis, subsequently, you can then start to focus on some of the more strategic. Insights driven work as to

Paul: where do you want to

Baxter: be? Yeah. Where do you want to be? When you the fun stuff. I mean, that’s really, nobody

Paul: likes the boring stuff.

Nobody wants to eat their broccoli. They want to eat the ice cream. And, and that I live in a world where we’re trying to get people to eat the broccoli. I mean, it’s just, it’s not, but, but that’s not the objective. You know, the objective is let’s get to, let’s get to something good. Let’s figure out, let’s do the fun stuff.

Like let’s get to the fun stuff. We got to go through the trenches.

Baxter: Any questions from folks as we open it up? I mean, again, I think this is meant to be, you know, very community driven, if you have any questions, more than happy to allocate, you know, 12 15 [00:47:00] minutes here with Paul, who’s obviously an expert, you know, been in this space for a very, very long time, works very, very closely, um, with You know, many different MSPs across the U.

S. I don’t know if you cover any other geos outside of the U. S. today, U.

Paul: S.

Baxter: based, really U. S. based. Um, So,

Steve: somebody submitted a question privately to me, um, I, you know, I just assume at this point you’re giving free accounting advice. Yeah. So, uh. What’s the

Paul: disclaimer I’m supposed to say before I answer anything?

Where’s my lawyer?

Steve: Yeah. Yeah. So, uh. It’s gonna

Baxter: cost 1 per year.

Steve: Yeah. So, is there An accounting or tax advantage, uh, between being an LLC filing as a sole proprietor, being an LLC filing as an S Corp, or being an S Corp? And at what point does it strategically make sense to switch between them?

Paul: I do [00:48:00] have an answer for this.

Let me give you my, my fake answer. That’s actually the actual answer. It’s, it depends. That’s the, that’s the answer. I can use it every, I mean, and it really does, right? Like I’ll put a spreadsheet. I have a spreadsheet together that I will, I will, I do an S corporation tax savings example. So. Uh, when, when you start, I mean, look at MSP goes out and the guy starts it out of his, uh, his basement and all of a sudden, you know, everybody, all of his customers, he starts making a hundred thousand dollars in, in revenue.

And I’ve had dozens of these people come in, Hey, I made, I, I just crossed a hundred thousand dollars in revenue and I’m making X amount of, I’m making, you know, 45, 50, I just started it out. And then I’m, I’m off and running at a certain point. You do want, there is a tax advantage to being an S Corp.

There’s a reason that so many small businesses are using S Corporations. Because you end up putting yourself on the payroll and limiting your FICA, um, your payroll taxes. [00:49:00] Now, um, where that point is, there’s the wiggle room, Steve, to answer that question, there is the wiggle room there, but I, you know, I, I know, I’m not sure if this person’s going to be on the call, but I had a long call with somebody who was very disappointed they were put into an S corporation, I, I said, I think that’s a, there’s, there’s a point where you want to, okay, so an LLC taxes a sole proprietor, you’re subject to, you have some legal.

Yeah, I don’t want to get into legal advice, but there are some legal limits on the LLC, but you don’t get any tax savings.

Baxter: So I share share Paul’s email and feel free to email him directly

Steve: and I can’t remember the book You guys probably know the book though. There’s a book that every business owner should read I think it might be profit first where it basically says if if you’re not paying taxes Then your business is not [00:50:00] profitable So I think I think what happens is people who are an LLC filing as a sole prop They’re able to like Finagle things and hide as much as they possibly can as business expenses and, and to switch to a, an S Corp, that means now they don’t get to write off all these business expenses as, as personal expenses on their taxes.

And they, they don’t see that, that they’re, they’re saving money in the big picture of things. They see, I’m screwing myself personally. You know what I mean? So I think what people need to understand is, bottom line, if you’re not paying taxes, your business is not generating profit.

Paul: You, you want to be a little bit depressed on April 15th, right?

Like the most successful people. are sad. It hits them every year. March 15th to April 15th, [00:51:00] and they have to cut that check. That is a sign of success. I have listened to one guy, uh, Greg Crabtree, who says the most important KPI you have in your business is how much you paid in income tax. That’s how much money you’re making.

If you’re, if you’re not, now look, as a CPA, I love to try to play with those things and get money down and play a shell game and try to minimize that for people. But really, if you’re, if you’re not paying taxes, you got to wonder, are you really, are you really making money?

Baxter: I like this question. Sorry, just to change the subject, just because we know we have a few minutes, but

Steve: yeah, that’s where I was going to go to another one.

Baxter: Cool. Should your CPA and bookkeeper be separate vendors? Yeah.

Paul: Hmm. That’s a good question. Uh, we have chosen, uh, I’m, I’m going to keep them the same. Uh, and I’ve made that decision as far as my company is concerned. Uh, there are, uh, yeah, there’s pros and cons on that one. The way I like about it is that there’s a communication there, you know, I can hop in teams and say, what do we do with this?

Uh, what, what’s going on over [00:52:00] here? Is this really where I want it to be? There’s an access, uh, it’s just a whole lot easier. Um, there is a different approach to a bookkeeping than it is on a tax. I mean, it’s, it’s a very different, one’s a, one’s a flywheel, you get it going. But yeah, the, I, I prefer, I think the, the value to the client is they don’t have to take their books and to someone else and get in line with the other company to, to have their, their stuff done.

Baxter: I think the. The big concern, typically, is if they are the same person, there’s potential fraud ramifications, right, if somebody is stealing money, um, so keeping them separate, you know, provides accountability for both individuals, allows you to kind of audit each other, um, but, you know, we, we certainly, our accountant and our bookkeeper are the same for our business, um, I think most businesses, you know, there may be a separate account.

Tax filing, you know, group. But [00:53:00] typically they’re one and the same. You also have a fair amount as, especially being a small business, there’s a fair amount of cost savings associated with, with that. Um,

Steve: I, I remember having that concern when I ran my MSP of, you know, what? What if, I felt like I needed checks and balances between the CPA and the bookkeeper.

And, and what, I just assumed that they, they were both equally knowledgeable. For some reason, I had it in my head that like, if the CPA screwed up, the bookkeeper would let me know, and vice versa. But, there are so many things that a CPA knows that, Bookkeepers just aren’t privy to because they don’t, they don’t need that knowledge to manage the books.

So, I, I agree with you completely, Paul, that, um, you, you [00:54:00] should probably stick to the same company. Go with a bigger company, that way they’ve got multiple people, that way you can still have your checks and balances, but go with a single company that’s able to provide your CPA and your bookkeeping, so that way it’s all, they just can talk to each other and mesh really well.

Baxter: I think it also depends if people are handling accounts receivable, right? Like how, where does the CPA and bookkeeper kind of stop and start, right? Are they also paying bills? You know, I forget, it was, um, uh, there was a big, oh, it was actually a very, very large company. I guess this is probably off topic, but a company called Trafigura, which is a massively publicly traded company.

You know, they had a separate group that was paying accounts payable in Mongolia on behalf of the company, and they were inflating all the books, invoices for accounts payable by like hundreds of thousands of dollars. So this group stole over a hundred million dollars. From the pairing company. Um, what I think this is [00:55:00] also a good question.

Like what’s that, what are some quick metrics that are helpful for an MSP to track, um, and see where you are at without digging into the books?

Paul: Well, one of the, one of the easiest as taking your W 2s on service based professionals, client facing professionals and multiplying it by two and a half to see how close that comes to your revenue from service revenue, that, that’s, that’s the, that’s the easiest one that people can come up with.

They can take a look. Sorry to interrupt quickly,

Baxter: Paul, you go to your payroll provider. You download everybody who’s in the tech side, right? The service, service providers.

Paul: Even, even easier than that. Just say, I’m paying this person X. I’m paying this person X. Add those up. Multiply it by two and a half. And then see how closely that comes to just your service revenue.

You know, that, that is the best thing. That’s where you want to be.

Baxter: If it’s one for one, what does that mean?

Paul: Well, that’s, that is a, an [00:56:00] optimal level. It means you priced it correctly. You have the right amount of service techs in that business. So, uh, it’s, you know, your service people always want more people.

They always want to hire more people. So there’s always a push that, well, you got to get more, we’re this way cause we don’t have enough help. And there is, if you, if you back into that, if you have your accounting where, where you want it to be and you can back in and say, well, you know, buy our numbers and it’s just a big puzzle.

Uh, you’re putting together this big puzzle, but you’re saying this is, this is where, this is where it should be. This is where the best in class is. This is where we’re going to hang out. And. And, and you have information that you can hand to somebody and say, no, this is, this, this, this is why we are where we are.

Baxter: That would almost imply that your service level headcount is at a 60 percent margin for that business, gross margin for that business. Yep.

Steve: I want to know a couple more metrics, but first, um, do you guys provide bookkeeping services at Red Earth?

Paul: [00:57:00] We do. Yeah, we do. We’re going to, we, we will, we, we provide it for MSPs and that’s really where our niche is.

We, we camp out and study this stuff because we want to be able to implement it right into our books, um, from bookkeeping to benchmarking. We want to take people to the summit. You know, we have a, our website, uh, redearthcpa. com. We have a. A little graphic in there, Journey to Peak Financial Performance, and it, it will illustrate what characteristics are of certain people at certain stages, and we put that into an assessment.

You can click on that assessment, it’s a 35 question assessment, and you can assess yourself. That’s all it is. It’s, you know, it’s a, it’s a way of, of looking at your company and saying, how, how well am I doing in organizing and, and investing the time and energy into the back office of my company.

Baxter: Very, very cool.

I think last, I’ll address these last questions, Steve, and then, um, we’ll wrap it up. I think [00:58:00] there are two questions. One is, you know, again, metrics. I think a metric that I would add would be day sales outstanding, right? Which is how quickly are you getting paid from your clients? If your day sales outstanding are average 20 days, then that means that your clients on average are paying you in 20 days.

If they’re one day, that means you’re getting paid immediately. Um, and then there’s another question around secret sauce to bringing down the average days to pay. This is an interesting one because I typically in life think that there is no secret sauce to anything. It’s just a lot of hard work. But for this question, it’s all about, uh, auto pay.

Right, so ensuring that your clients that you’re servicing have a payment method on file, bank accounts, or credit cards. And you are setting up auto pay on the due date, which again, brings your day sales outstanding to hopefully zero or one, um, which would be a great, great metric, [00:59:00] but again, Baxter, I think you’re saying

Paul: that, uh, early and often on expectations as well, you’re setting the expectations and the sales process that this is exactly how we work.

This is how it goes. And if you don’t want to be a client, that’s okay, but this is how my clients, this is how our clients pay us.

Baxter: Want to be respectful of everybody’s time. This has been a great hour. Thank you so much for joining. Um, we will be continuing this series, um, every, what is it, Steve?

Steve: It’s every other Thursday.

So we’ll be back in two weeks and, uh, we’re going to have a different guest with us then. And we’re going to talk about, uh, picking the right accounting software. And then in four weeks, we’ve got Paul joining us again. What are we talking about then, Paul?

Paul: You’re gonna put me on the spot right there, Steve.

I was gonna look at that before you asked me. We’ll

Baxter: have to build the agenda in the next

Paul: four

Baxter: weeks. But we’ll continue to dig in on accounting. [01:00:00] We’ll also dig in in M& A and have a separate speaker series around M& A. Super excited. If you guys have any feedback, please share it with Steve. Please share it with me.

Please share it with Paul. Um, and excited to continue to build, build this community, build this network and hopefully provide really, really high quality, valuable resources to you all. Have an awesome day and awesome evening. And we will chat soon.

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