For many Consumer Packaged Goods (CPG) companies, accounting principles aren’t top of mind during the early growth stages. Considering founders have to juggle many moving pieces, it’s easy to see how accounting best practices take a back seat. However, we can’t understate the importance of disciplined CPG accounting and financial practices — especially early on.
Your numbers impact everything. They help business owners make sound, fact-based decisions. They help companies foresee potential financial pitfalls and challenges. They affect an investor’s or lender’s willingness to provide capital.
Disorganized and neglected financial processes will compromise the growth and longevity of your company. So, it’s prudent to understand and implement the following CPG accounting fundamentals.
Many young companies elect to record financial data based on the movement of cash. You sell goods to a local store, which has 30 days to pay your invoice. Since you’re tracking cash, you wouldn’t recognize a sale until the store actually pays you in 30 days or so. This method is known as cash basis accounting — and it’s not the most strategic method for a new CPG company.
Why? Because cash basis accounting doesn’t give you holistic oversight of your finances. You can’t accurately calculate your margins or cost of goods sold, so it’s much harder to analyze month-to-month operations and glean insights from your data.
Instead, businesses that use accrual accounting (which is often referred to as GAAP basis Accounting) can leverage data to make informed and calculated decisions that focus on business performance and not just cash. Under this accounting method, you would recognize revenue when it’s earned — not when cash changes hands. Looking back at our previous example, you would recognize your sale to the local store upon delivering those goods — not when they pay the invoice 30 days later.
Accrual accounting enables you to see trends, correlations between sales and COGS, true margin levels, and much more. You can analyze your business’s performance from period to period, empowering business owners to make the right decisions early on.
Creating a comprehensive and industry best practice “chart of accounts” is a simple step that will help you avoid major headaches later on. A chart of accounts is a list of your company’s transaction type ‘buckets’, which you’ll use to categorize and classify transactions in your general ledger.
For example, your chart of accounts may include the following sub-accounts under assets:
Hiring an industry experienced accountant or bookkeeper to assemble your chart of accounts correctly is a worthwhile investment in the long run. Because food manufacturing companies operate much differently than other industries, it’s critical to produce financial reporting that’s comparable to others in your industry as well as comply with reporting standards.
Beyond making your day-to-day CPG accounting responsibilities easier, a strong chart of accounts also gives potential investors clear insight into your business’s financial health.
Data is invaluable to a new company. It tells the story of what's happening. However, that’s only the case if the information is consistent and organized. As an emerging CPG company, your data sets are your transactions, accounts payable, inventory changes, invoices, and so on. Whether you use a financial system like QuickBooks or Xero, you must standardize your data recording process. Implementing a data strategy will help you create a financial roadmap, identify trends, and expose financial constraints or issues.
Inconsistent data is a common issue for new companies, which leads to convoluted financial roadmaps. They can’t see investment opportunities — or areas of overspending. They can’t accurately plan for scale and how to sustain it. Decisions based on flawed data lead to missteps that can delay or outright prevent growth.
Standardize your data at the onset — ensure you’re inputting data into your accounting system the same way, in the same format every month. This can help prevent simple financial mistakes from inhibiting progress.
As your business grows, the key to financial success is knowing your cash inside and out. You should know how much you have, where it’s coming from, and where it’s going. In other words, cash flow management looks at your past, present, and future cash to guide various business decisions.
For instance, cash flow management helps you monitor critical financial indicators such as trade spend. It’s common for CPG companies to divide trade spend into two different buckets: variable and fixed. Variable trade spend is ongoing; you may have a 3% partner fee with a major grocery retailer that allows you to sell products on their shelves. It’s a necessary, recurring cost of doing business with that retailer. On the other hand, fixed trade spend is a one-off expense. You may have to pay a one-time fee to access another point of distribution within a store.
Tracking these types of indicators will provide long-term returns for your business, as potential investors will want to see how you’re supporting your brand’s growth.
Cash flow management also allows you to forecast operations more accurately and make informed predictions about your business’s growth, hurdles, and capital needs. However, that doesn’t mean forecasting is an easy task. Assessing your future balance sheet and income statement — and how they correspond with one another — requires reliable data. (See why data consistency is crucial?)
For CPG companies, your future balance sheet drives your future cash needs, like capital expenditures and raw material procurements. So, you should regularly forecast your next two years of cash flow to ensure adequate lead times and liquidity. Based on your models, you can address capital needs sooner rather than later. This type of planning is imperative because securing a loan or raising equity takes time — time you wouldn’t necessarily have in the middle of an unexpected liquidity crunch.
The final CPG accounting principle is truly a mindset: address financial problems now instead of later. We see many business owners avoid the above accounting principles because they’re overwhelmed or reminded of active risks.
This avoidance often manifests in the form of a bootstrapping mentality. While being cost-conscious seems like a good idea now, this mindset can create higher costs down the road.
For instance, it’s tempting for new companies to take the cheaper route and employ a bookkeeper over an accountant. The former costs less but doesn’t have the same background, knowledge, or skillset. While a bookkeeper can help maintain transactional data, they often can’t match the strategic, big-picture analysis and insights of an experienced accountant.
It’s essential to take a more proactive approach — your numbers empower you with visibility and choices. That often means spending a small amount now to save a more considerable amount later.
Do you risk building a business on a house of cards? The decisions you make now have long-lasting financial repercussions. If you question your team’s ability to manage the above responsibilities, outsourcing is a viable solution.
AVL helps CPG companies navigate early financial hurdles, such as creating and continuously updating business plans or developing financial models. Want to learn more? Visit our website to connect with us.