Like many advisors, one of my clients kept his financial records in what I call "the glorified checkbook" system: he wrote down the money that came in, the amount he paid out, and if anything was left in the checking account at the end of the month, that was great. For years, I tried to get him to move to a more detailed accounting system, but he didn't want to take the time or make the effort that such a change would require, and kept putting me off with the old "if it ain't broke, don't fix it" rationale.
Finally, at the beginning of this summer he agreed to make the leap; buying QuickBooks online accounting software and having all his 2008 transactions entered into it. The transition was going swimmingly until he discovered his administrative assistant had been charging personal items on the company credit card–over $15,000 worth this year, alone. Before now, all my client had ever looked at was the monthly balance on the card and signed the check to cover it.
I'm sure I don't need to point out the irony in the fact that a significant number of financial advisors don't keep adequate financials. The old check book system lacks the checks and balances necessary to ensure that you're not over-charged by your vendors, underpaid by your clients or broker/dealer, or in the worst case, the victim of financial fraud. What's more, it doesn't give you the financial information you need to make successful decisions about where to direct your resources to grow your practice, or maximize your income. In fact, I believe that inadequate accounting is probably the leading cause of stagnating advisory practices today. The real irony is that good bookkeeping isn't rocket science–and once in place, it's actually easier than the patchwork "system" you're probably currently using.
More Is Sometimes Less
Now, before you write me off as na??ve, rest assured I do understand the issue of small business taxes–that the goal of most small businesses (and all independent advisory firms fall into the category of small businesses) is to take as much money as possible out of the business as deductable expenses, leaving as little profit as possible. While there's no data on this, I believe most advisors use the checkbook accounting system in the mistaken belief that these vague records will make it harder for the IRS or state tax auditors to determine whether your deductions are legitimate or actually personal expenses in disguise.
Here's a news flash for you: They don't have to determine if your deductions are legitimate or not, the law says that's your job. And worse, there's no bigger red flag for an auditor than confused bookkeeping, especially in a financial business. The reality is that the best defense to an IRS challenge is clear, accurate books that spell out where every revenue penny came from, and what every expense penny paid for. When auditors have nothing to question or disagree with, they tend to lose interest. Plus, without adequate bookkeeping, you can't do tax planning–you may not want to increase your quarterly tax deposits, but if you're making a lot more money this year than last, you might want to put some of it away to pay those additional taxes at the end of the year.
In addition to a much sounder tax footing, good financials make it easier to run your practice, and your life, in myriad ways. For instance, I've observed that a recurring pattern for many financial advisors occurs when their practice revenues begin to grow substantially, which often happens when revenues hit the $250,000 to $500,000 range. With a more successful firm, advisors often feel that they can finally start to improve their–and their family's–lifestyle: An "I'm making more, so I can spend more" mentality.
What they don't realize, particularly if they don't have good financial data, is that the firm's expenses are usually rising, too. In fact, expenses at many firms in this range will actually be growing faster than revenues, which means that the advisors will be taking home less, not more money. Then to fund the shortfall that their premature lifestyle bump created, they take on more personal debt, that will take years to payoff, and create increased pressure to grow their firm even more.
