Dan Martell - What is Accrual Accounting？ (See The #1 Decision Startups Need to Make TODAY)

00:00:00.000 Hi there, Dan Martell here,

00:00:01.140 serial entrepreneur, investor, and creator of SaaS Academy.

00:00:03.500 In this episode, I'm gonna share with you

00:00:05.120 what is accrual accounting, accrual versus cash.

00:00:08.840 Hey, first off, I'm not an accountant,

00:00:11.020 but I play one on the internet.

00:00:13.120 I literally have read and looked at

00:00:15.300 probably 2,000 different balance sheets,

00:00:19.300 P&Ls, cashflow statements, you name it.

00:00:22.020 And I've had to teach dozens of SaaS founders specifically,

00:00:26.400 and that's why you wanna watch this,

00:00:27.300 on how to think about accrual accounting

00:00:30.200 versus cash accounting. 0.98

00:00:31.800 It's not as complicated as the frigging accountants 0.94

00:00:33.940 wanna make it seem, but be sure to stay at the end 0.81

00:00:36.000 because I'm also gonna share with you

00:00:37.040 my precision scorecard, a framework to help you understand

00:00:40.040 how to measure specifically deferred revenues

00:00:42.340 and other things we're gonna talk about in this video

00:00:44.100 so that you get a weekly report to keep your eye on,

00:00:47.560 to make sure your business is moving

00:00:48.780 in the right direction.

00:00:50.080 Let's get into it.

00:00:57.300 So here's a funny story.

00:01:04.780 Back when I was building my company, Spheric,

00:01:06.300 I had done two other companies prior to that point

00:01:08.980 and they failed, okay?

00:01:10.120 Maritime Vacation and NB Host.

00:01:12.060 And I finally start with Spheric Technologies

00:01:14.120 and somewhere in one of the business books

00:01:16.320 I was reading at the time,

00:01:17.140 they say you really need to understand your numbers.

00:01:18.980 You've heard this from so many people. 0.88

00:01:20.980 Telman Fertitta, a crazy restaurateur, 0.86

00:01:23.800 incredibly successfully billionaire, 0.82

00:01:25.460 talks about it.

00:01:26.000 You need to know your numbers.

00:01:26.840 Warren Buffett, need to know your numbers.

00:01:28.420 And I was just like, man, I know how to make money,

00:01:31.720 but I don't understand what the accountants do

00:01:33.780 with all those transactions.

00:01:35.260 Like I can't tell you how to read an income statement

00:01:39.020 or a cashflow statement or a balance sheet, et cetera.

00:01:43.080 Like they were all things that were like,

00:01:45.240 I had them and I had to sign off at the end of the year

00:01:47.360 to make sure they were accurate because if, you know

00:01:49.320 I could go to jail if I didn't pay my taxes, et cetera.

00:01:51.420 But I didn't understand.

00:01:52.960 So I reached out this guy named Dave Ritchie.

00:01:54.600 He was a local entrepreneur.

00:01:56.240 He owned a shipping company, a dry cleaning company,

00:02:00.520 some restaurants, some real estate.

00:02:02.460 And I remember this,

00:02:03.200 and he was probably about 14 years older than me.

00:02:05.020 And I reached out to him, I was just like,

00:02:06.080 hey, Dave, I was wondering if you could teach me

00:02:08.060 how to read financial statements.

00:02:10.000 And he was kind enough, like knowing what I know now,

00:02:12.440 how ridiculous that request was.

00:02:14.200 He replied and he's like, hey, Dan, I'd love to meet up. 0.89

00:02:16.820 I'll teach you what I know.

00:02:18.120 But the truth is, is that's what accountants are for.

00:02:21.500 And I kind of dove into it and realized like,

00:02:24.440 he was right at the end of the day,

00:02:26.240 the accountants should do all the heavy lifting, 0.90

00:02:29.140 but what you're responsible to do

00:02:31.080 is to direct them into the right way.

00:02:33.020 So I'm gonna share this

00:02:34.340 because accrual accounting for SaaS is a must.

00:02:37.260 It makes it ridiculously impossible

00:02:39.100 to understand the business if you don't do it.

00:02:41.720 So let's dive into the specific aspects

00:02:43.660 and why it's important for you.

00:02:45.680 Number one, clearer cashflow in better decisions.

00:02:48.840 So what the difference is, okay,

00:02:51.100 is accrual accounting essentially says

00:02:53.420 the income is collected when the service is delivered, okay?

00:02:57.760 So if somebody pays you for an annual contract upfront,

00:03:01.260 you didn't deliver the service yet.

00:03:02.960 You might've delivered that month's value,

00:03:05.020 but you didn't deliver the whole year.

00:03:06.900 So what ends up happening is that check for 100 grand,

00:03:10.020 or let's use 120,000 so we keep the math easy,

00:03:12.860 is 10,000 every other month is looked at

00:03:16.500 as like accounts receivable.

00:03:18.040 It's an invoice for a future date,

00:03:20.100 owed on a future date versus cash versus saying in my account, which is look, the truth is small

00:03:26.300 businesses all around the world. They do cash accounting. I get it. It's simple. They're like,

00:03:30.480 am I doing good? How much money is in my bank account? But that's not a true understanding of

00:03:35.520 how your business is doing. Because the last thing you want to do is have all these customers,

00:03:39.060 you're doing three year annual contracts and they give you all the money upfront and you're

00:03:43.660 sitting on millions of dollars of, of what you think is profit. But the truth is, is you still

00:03:48.300 have to operate. If you just think about you got expenses for three years into the future that's

00:03:52.760 coming from that pot of money. And if you don't look at the reporting from an accrual point of

00:03:57.300 view, you're going to think that you're rich. You're going to go buy yourself a new Lamborghini

00:04:00.280 and then you're going to have customers pissed off because you don't have any developers,

00:04:03.800 no money for the servers, no money for customer support, and they're going to leave and then ask

00:04:07.740 you for their money back, et cetera, et cetera. So, I mean, that's the real reason is you want

00:04:12.120 clear cashflow understanding so you can make better business decisions about should you hire

00:04:15.780 or that extra engineer?

00:04:17.300 Are you able to upgrade your systems?

00:04:19.160 Should you buy or change CRM solutions, et cetera?

00:04:22.060 Whatever's gonna cost you money.

00:04:23.740 If you don't have an accrual process

00:04:26.180 to project into the future

00:04:27.860 to understand what your cashflow is gonna look like,

00:04:29.660 it's gonna make it harder to make good decisions.

00:04:32.280 Number two is we wanna track MRR with accuracy.

00:04:35.840 MRR stands for monthly reoccurring revenue.

00:04:39.180 And I remember one time I was working

00:04:40.760 with a coaching client, Adrian,

00:04:42.000 and I said, hey man, what's your MRR?

00:04:43.620 He goes, I don't know.

00:04:44.680 I know my ARR.

00:04:46.140 Well, the good news,

00:04:46.980 if you know your annual reoccurring revenue divided by 12

00:04:49.600 and that'll give us our MRR.

00:04:51.060 But here's the risk of not knowing MRR

00:04:54.900 is if your goal is to double in revenue,

00:04:57.220 your 2 million ARR and you wanna go to 4 million

00:04:59.900 is the incremental change on a monthly basis for ARR

00:05:03.560 is so, it's so small.

00:05:05.020 You go from two to 2.2 to 2.4.

00:05:08.020 It doesn't feel good as a percentage.

00:05:10.200 It might look, you know, if you're getting 7, 8% a month

00:05:13.440 But what I love is the monthly.

00:05:15.280 I love focusing on the monthly

00:05:16.920 because what I learned a long time ago

00:05:18.200 is the more frequently we can measure

00:05:20.820 and change and effect.

00:05:22.100 And the beauty of software is we can get down

00:05:23.600 to the weekly numbers.

00:05:24.660 We can look at our pipeline and our revenue

00:05:27.340 and cash collected.

00:05:28.480 We can still get the cash portion,

00:05:30.960 but we can start looking at MRR

00:05:33.100 and are we growing it on a month over month basis?

00:05:36.240 And it helps us smooth out all those,

00:05:39.000 maybe we have customers that are not gonna renew,

00:05:41.680 or maybe you have different changes in your prices.

00:05:45.140 If you don't look at it on a monthly basis,

00:05:47.280 you won't see those big shifts to give you feedback.

00:05:50.380 So tracking MRR accurately is the biggest reason

00:05:53.720 for you to move to an accrual-based accounting process.

00:05:56.460 Number three is identify business trends.

00:05:59.900 So I remember one time I was working with another client,

00:06:02.520 Emrick, he had made a big pricing change in their software.

00:06:05.720 They have a social media marketing software.

00:06:07.940 And because they weren't looking at things

00:06:09.780 on a monthly basis, on an MRR level, monthly.

00:06:13.180 And it was just kind of like going.

00:06:14.540 That pricing change had a negative effect.

00:06:16.760 But the first month that had a negative effect,

00:06:18.580 they just assumed, oh, you know, it's that time of year,

00:06:20.600 September, it's a slower time of year for us.

00:06:22.440 Then the next month they were like,

00:06:23.700 oh, maybe there's something going on, blah, blah, blah.

00:06:26.160 It took three months, 90 days for them to realize,

00:06:28.620 holy moly, that change we made back three months ago

00:06:31.200 has reduced our monetization by 20%.

00:06:34.700 Change it back.

00:06:35.880 We need to really focus on the monthly costs,

00:06:40.620 the monthly expenses, the monthly income

00:06:42.660 so that we can make a better identification

00:06:45.380 of business trends, both support tickets, costs.

00:06:49.660 Like everything and your core business

00:06:51.460 needs to be done on a monthly basis

00:06:53.740 in regards to when the service was delivered

00:06:55.560 and when the expense was occurred

00:06:58.520 so that we can get a, ideally reduce the distortion.

00:07:02.240 That's what it's called is distortion in your numbers, okay?

00:07:05.080 So make sure that you look at accrual

00:07:06.920 so that you can make better identifications

00:07:09.300 of business trends so you can make better decisions.

00:07:11.540 Number four, financial implementation.

00:07:13.760 So two things you need to understand

00:07:16.120 to just implement this.

00:07:17.240 As an entrepreneur, it's really simple.

00:07:19.200 Is the income, it's deferred as receivable,

00:07:22.480 so it's paid up front.

00:07:23.360 So if they pay on a monthly basis,

00:07:25.600 no worries, no harm, no foul.

00:07:27.120 That's easy because they're just gonna pay their credit card.

00:07:29.160 But if they pay up front,

00:07:30.200 you wanna defer that income as deferred revenue

00:07:32.840 and it shows up as a receivable in your books, okay?

00:07:35.640 So deferred revenue.

00:07:36.520 So you might have a bunch of cash,

00:07:37.940 but every month you might have a deferred revenue line,

00:07:40.520 which is the amount of money that you expect

00:07:42.120 because clients pay you every month

00:07:43.600 and that's gonna show up.

00:07:45.020 And the second thing is your expense

00:07:46.600 should occur the day of service.

00:07:49.320 So maybe somebody invoices you today,

00:07:51.900 but you don't actually get them to do the work

00:07:53.860 until the future, or they do the work,

00:07:55.960 but they don't invoice you until 30 days later.

00:07:58.420 From an accrual point of view,

00:07:59.640 you want to record the expense on the day of service delivered. That's how this whole thing

00:08:06.160 gets cleaned up. That's why people are like, what if people pay me up front? I just answer the

00:08:10.140 question. You defer it as a receivable that they owe you every month. And if you get a service,

00:08:15.700 you need to expense it on the day they delivered the service. It has nothing to do with when you

00:08:20.260 paid it or when the invoice was given to you. So that is accrual accounting. You need to do it as

00:08:25.440 a SaaS founder just cleans up everything. Number one, it clears up your cashflow. Number two,

00:08:29.720 it helps you track MRR accurately. Number three, identify your business trends. Number four,

00:08:35.980 most important is the financial implementation of it all. And the good news is you ask your

00:08:40.920 accountant to do it. You don't need to do it. Now, I mentioned at the beginning of this episode,

00:08:44.880 I want to share with you my precision scorecard. It is a framework and a template that you can

00:08:50.820 implement into your business to track your revenue,

00:08:53.420 track your expenses, track your profit on a monthly basis.

00:08:56.640 Because here's the deal.

00:08:57.900 If you have profit and you don't reinvest it

00:08:59.940 into next month under growth opportunities,

00:09:02.320 you're giving up seven times potential revenue

00:09:05.140 or valuation into the future of your business

00:09:08.680 because that dollar reinvested could have helped you grow

00:09:11.800 in your monthly reoccurring revenue.

00:09:13.340 And the valuation on average for a SaaS company,

00:09:15.880 if they're doing about, you know, 3 million plus

00:09:18.380 is about between four to seven X their top line MRR.

00:09:22.320 So if you've got profit, you wanna reinvest,

00:09:24.580 the Precision Scorecard will help you track that

00:09:26.580 on a weekly, monthly basis,

00:09:27.900 help your team get focused on quarterly outcomes,

00:09:30.880 build the accountability,

00:09:32.100 just click the link below to download your copy

00:09:34.680 of my Precision Scorecard Framework.

00:09:36.400 And if you liked this video,

00:09:37.860 even though it was super dry topic,

00:09:39.480 accounting, literally, I find it boring,

00:09:42.280 but without it, we don't have the optics

00:09:44.620 and the visibility to grow our business.

00:09:46.020 be sure to like this video,

00:09:48.200 share it with somebody that you know

00:09:49.740 is having this issue or not doing it right

00:09:51.940 so we can get them straight

00:09:52.980 and be sure to subscribe to my channel.

00:09:55.200 As per usual, I wanna challenge you

00:09:56.820 to live a bigger life and a bigger business

00:09:58.660 and I'll see you next Monday.

00:10:02.140 Boom.

Dan Martell - November 16, 2020

What is Accrual Accounting？ (See The #1 Decision Startups Need to Make TODAY)

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