About Part Three: An Inquiry into Systems
Part Three is an Inquiry into Systems. It has [ ] sections:
Section 1: It’s Time For A New Map lays the groundwork for reimagining financial accounting. We advocate a shift from traditional accounting, which serves to protect investors, to a weekly accounting system focused on providing real-time insights that truly benefit the business. The section highlights the limitations of conventional CPA (Certified Public Accountants) practices, especially for small businesses, and emphasizes the need for more relevant, empowering data. Through the story of Brave Health and their use of “Monday Morning Metrics,” it demonstrates how timely data can significantly improve business operations.
Section 2: The Language of the Weekly Accounting System delves into the conceptual framework of Weekly Accounting. We discuss the need for a new ‘language’ and ‘map’ to navigate the complex transactions and flows within a business, moving beyond the traditional income statement and balance sheet. The section introduces the idea of “Rowsets” – collections of related data that offer a more dynamic and useful view of business performance, including the ‘Flow’ Rowsets like income statements and ‘Balance’ Rowsets like balance sheets. It then moves to detail the ‘Revenue Engine’ of a business, explaining how it functions and the importance of ‘Unit Economics’ in assessing and driving business growth through real, quantifiable metrics.
Section 3: The Components of Weekly Accounting
Section 4: Getting Started
The Not-a-Book: The rest of the not-a–book is blank. It’s a space for you to think about your business in a new way.
The chapters are short and begin with a poem. The first chapter makes the case for change: It’s time for a new map.
Section 1: Time for a New Map
Right Data, Empowered Team
“Have you seen the Monday Morning Metrics?” Jake texted one Saturday morning.
I met Jake Schwartz ten years ago when he was co-founder and CEO of General Assembly. Today, he was texting about his current company Brave Health, a provider of mental healthcare for Medicaid and Medicare patients.
We had been helping the team at Brave see their business better since they raised $40 million in venture capital a few months earlier.
Monday Morning Metrics (“MMM”)is a core component of Weekly Accounting.
It was just a few weeks into January, 2023. Therapists were completing more therapy appointments per day than they ever had before – 27% more in the first quarter as compared to the fourth.
I made a quick weekly chart and texted it back to Jake.
The results were amazing, but not surprising. We see it all the time. It’s simple.
When you put the right data in front of an empowered team, they get better.
But what is the Right Data and how do you empower a team? That is less simple, but it is learnable. That’s what Zen and the Art of Weekly Accounting is about.
The Intention and the System
It starts with an intention,
And turns into The Word,
Sample progress in a row set
Precise, like hummingbird.
Compare the row set to intention
An accounting every week
Make predictions of the future
The system then will seek.
If still not good then you will know
Exactly what to do
Mind or system has to change
The fix is up to you.
It Starts With An Intention
The intention of Weekly Accounting is to help people see their business better.
This is in stark contrast to what the traditional Certified Public Accountants (“CPAs”) are trained to do. Consider the irony of this reality:
A CPA is a license to do your books
in a way that doesn’t help the business.
Imagine an entire multibillion dollar industry dedicated to putting financials together in a way that does not help businesses that pay them. it is not their intention to help the business.
The intention of traditional accountants in the CPA industry is to protect investors from fraudulent management teams.
I’ve been a CFO (Chief Financial Officer) for startups and small businesses since 1998. In that time I’ve interacted with CPAs about twenty-five times – just to file taxes and to get compliance audits done before an IPO.
CPAs Don’t Help Small Businesses
There’s no money for CPAs in helping the smallest businesses get started and run better. As a result CPAs only focus on filing small business tax returns.
As a result, the books of most small businesses suck. We’ve seen thousands of them. We’ve cleaned a lot of them. Most of the CEOs we talk to don’t really even use their financial statements. They use bespoke reports from each of the applications that they run their businesses on.
Accountants Aren’t Even Trying
Accountants went to college to get a Good Safe Job. They are not risk takers. They are box checkers. They fill out forms and follow procedures. Creativity is frowned upon. The last thing anyone wants is an innovative accountant.
There is literally no upside to a job in accounting – only downside. There’s never any good news from accountants. The only time accountants are in the news is when there’s a catastrophe – like Arthur Anderson shredding documents while Enron collapses. Or FTX executives pleading guilty to fraud. If accounting was working and there was more transparency those things wouldn’t happen.
There Is A Better Way
Fortunately there is a better way. It’s not complicated. We’ve taught it to many people and you can learn it too. We’ve proven that it works at small businesses in nearly every major industry – from education and healthcare to lead generation and virtual worlds.
Once you see your business weekly, the old ways of seeing your business will seem quaint.
With all that said, accountants and accounting standards get a lot right. The standard financial statements – the income statement and the balance sheet – have transformed the world economy.
But in order to see something differently, we often have to learn some words or a new language. Weekly Accounting is a language. It’s a way of thinking about the information transactions and flows in a business and what can be done to influence them on a weekly basis.
That’s what Section 2 is about. The Language of the Weekly Accounting System.
But first a poem called “Using Language Like Math.”
Using Language Like Math
Everything is either
That or Not That.
Things that are Kind of Like That
are Not That.
Anything that can be
Pointed at or thought of is
Either That or Not That.
See for yourself! It’s a test of sorts.
An inarguable truth.
Sometimes you can find
Things That Break The Rule.
Even a Rule as Simple As That.
You might find, for example,
A mammal that lays eggs.
Mammals don’t lay eggs –
That’s the definition of a mammal. And yet,
A mammal that lays eggs –
Is called a Platypus.
If you find too many Platypuses,
In Your Math or in Your Language,
Then it’s Time To Question
Your First Principles,
The Implicit Assumptions
Embedded in your language.
Inevitably, when you face a situation frankly,
A solution appears.
This has been true for the
Whole history of civilization.
Insight never appears before it does.
Section 2: The Language of the Weekly Accounting System
We use maps to navigate the world. We use language to communicate. If our maps or our language don’t reflect reality accurately we either miss the destination or we can’t convey the point.
In business, we use the financials – the income statement and the balance sheet – as a map of what’s happening. The financials represent one way to look at all the cash inflows and outflows of money from a bank account.
But your bank account isn’t the only transactional system in a business and the financials aren’t the only way to assess the performance of a business.
In order to see a business better we’re going to have to learn a new map and a new language.
Flow and Balance
In the language of Weekly Accounting, an Income Statement and Balance Sheet are just two of the “Rowsets” of a business.
A Rowset is a collection of related rows of data about a business.
The traditional financial statements show the flow and balance of cash through the bank account into the various categories of stuff the business sells and buys. The income statement is a “Flow” Rowset and the balance sheet is a “Balance” Rowset.
A Flow Rowset, like the income statement, shows how much money moved during a particular period of time.
A Balance Rowset, like the balance sheet, shows how much money was sitting in a certain place at a certain time.
But your income statement and your balance sheet aren’t even your most important rowsets.
All the most important rowsets are embedded in the Revenue Engine.
The Revenue Engine
A Revenue Engine of a business is how it reaches and sells to customers and then how it gets paid for and delivers a result.
The Revenue Engine Rowset is like the dashboard on a car – a set of numbers that indicate the performance of the engine and the car on the road. When we “instrument” a revenue engine we are focused on the information necessary for calculating the unit economics.
Unit Economics refers to the direct revenues and costs associated with a particular business model, expressed on a per unit basis. In business, a “unit” could be a single product, a customer, a subscription, or any other quantifiable item that generates revenue.
The five components of unit economics are:
- Revenue Per Unit: This is how much money you earn from selling one unit of your product or service. For example, if you’re selling coffee, how much do you make from one cup of coffee?
- Cost Per Unit: This includes all the costs directly related to producing or delivering that unit. For the coffee example, this would be the cost of beans, water, cup, labor, etc., for one cup.
- Profit Per Unit: This is calculated by subtracting the Cost Per Unit from the Revenue Per Unit. It tells you how much you earn (or lose) for every unit sold. When it’s expressed as a percentage of revenue it’s called gross margin.
- Lifetime Gross Profit (LTGP): This is calculated by multiplying the Profit Per Unit by the average number of repeat purchases customers make. This works whether it’s a subscription business or a product business – more on that later.
- Customer Acquisition Cost (CAC):How much it costs to acquire a new customer.
Revenue Engine of a DTC Business
Because it’s generally intuitive to people, and has simple jargon, let’s consider the Revenue Engine of a Direct to Consumer (DTC) business, first in words, then in a rowset.
Direct to consumer businesses spend money to drive visitors to a website where the visitors view products in a catalog and buy them online.
And now the rowset:
The Marketing Funnel
The Marketing Funnel is a flow rowset that focuses on attracting potential customers to your business. It starts with Ad Spend, which is the direct cost of advertising efforts. Cost Per Visitor is then calculated to understand how much each website visitor costs the business. The number of Website Visitors and their Conversion Rate (the percentage that makes a purchase) are tracked.
If advertising isn’t performing as well as it used to, the Marketing Funnel Rowset separates the analysis into its workable components – Is our cost per visitor going up or is our conversion rate going down?
The Customer Roll Forward
In the first section of a direct to consumer revenue engine, we spent money on advertising, drove visitors to our website and converted them to customers. This flow rowset is followed by the Customer Rollforward – a balance rowset.
Remember, a flow rowset tracks something as it moves through stages over a certain period of time. A balance rowset shows how a balance of a certain thing – customers, inventory, receivables, or even employees – change over time.
The Customer Roll Forward Rowset tracks customer engagement and retention. It begins with New Customer Orders, indicating the number of first-time purchases. Repeat Customer Orders are then measured, highlighting customer loyalty and repeat business. Total Orders combine these figures, providing an overview of sales volume. The Repeat Purchase Rate is a crucial metric here, revealing the percentage of customers who come back for more purchases.
The life of a customer is calculated based on the repeat purchase rate sampled over time.
A “Roll Forward” is an important concept that accountants use to reconcile balance sheets. Weekly Accounting extends the concept to all balance rowsets.
A Customer Roll Forward. A customer roll forward is a method of tracking the changes in a customer base over a specific period. It starts with the number of customers at the beginning of the period, adds new customers acquired, subtracts customers lost, and results in the number of customers at the end of the period.
Inventory Roll Forward Example. It’s easiest to understand a roll forward as it applies to inventory. As an example, imagine you have a store where you sell books. At the start of the month, you count how many books you have – let’s say 100. This is your beginning inventory.
Now, throughout the month, you receive more books from suppliers, say 50 more books. This is your inventory addition.
During the same month, you sell some books. Let’s say you sell 40 books. This is your inventory reduction.
At the end of the month, you count your books again, and you have 110 books. This is your ending inventory.
An inventory roll forward helps you understand this flow of inventory. It’s like a story that tells you where you started, what you added, what you sold (or used), and where you ended up. So, it looks something like this:
See how the ending inventory of one period “rolls forward” to become the beginning balance of the next period?
Roll forwards are a powerful way to see how something we can count at a certain instant changes over time. For example, with an inventory roll forward we can also statistically calculate how long the inventory will last. That’s simply the ending balance of the inventory divided by the amount of inventory sold in the period. That’s how the “Weeks of Inventory Remaining” row is calculated. We’re going to cover more about this later.
In a direct to consumer business, Unit Economics breaks down the profitability and sustainability of the business model. Average Order Value (AOV) represents the average revenue generated per order. Customer Acquisition Cost (CAC) is the average cost of acquiring a new customer. The average number of purchases each customer makes is tracked, influencing the Lifetime Gross Profit (LTGP) – the total profit expected from each customer over their relationship with the business. The LTGP/CAC Ratio compares the lifetime value of a customer to the cost of acquiring them, a critical measure of long-term business viability.
As an aside, a lot of startup founders talk about their LTV to CAC ratio being 2.4x. When founders say something like that, sometimes say:
Meaningless statistics are up 6.7% today.
A statement like that creates more questions than it answers. I get specific about defining “Lifetime Value” or LTV as Lifetime Gross Profit (LTGP). Without defining it explicitly, I’ve noticed people calculate it as Lifetime Revenue which is a very different thing.
Cash Based P&L
A cash-based profit and loss statement simply categorizes all the cash inflows and outflows in the form of what accountants call a “direct cash flow.”
Gross Sales represent the total of all sales made. Netting out the Discount/Returns is Net Collections – the cash deposited in the bank.
After the cost of goods and advertising costs, is Cash Contribution – the bottom line of a revenue engine.
It is the cash left over after acquiring and servicing the customers flowing through the revenue engine – the cash left over to cover the overhead associated with the business.
The Instrumentation Pyramid
There is an art to putting together a rowset. People tend to clutter them. When that happens, we introduce the Instrumentation Pyramid.
The Instrumentation Pyramid
The Instrumentation Pyramid is a visual representation of how metrics cascade through an organization.
Level 1 Metrics are the minimum required set of metrics to accurately forecast the revenue engine of a business and see trends in Unit Economics. As an example, in the DTC Revenue Engine example above, the Level 1 metrics are ad spend, web traffic, conversion rate, average order, repeat purchase rate, product margin, gross margin. From these metrics we can accurately predict near term revenue and calculate the unit economics culminating in the return on acquisition cost as represented by the LTGP:CAC ratio.
Level 2 Metrics segment the Level 1 Metrics any number of ways including by customer type, product type, store, geography, sales channel and many more.
In the DTC Revenue Engine example, we’d break down the marketing spend to calculate CAC by ad spend channel, we’d also break down gross margin for the whole business into gross margin by product or by channel.
Level 3 Metrics segment the Level 1 and Level 2 metrics by how the work gets done including by department, by service provider, employee and others.
Section 3: Weekly Accounting System Components