Metrics for Every Stage of Ecommerce Financial Maturity.

Welcome to the Ecommerce Finance Podcast. I'm Stephen Brown of LedgerGurus. Today I have with me Geoff Gualano from A2X, and we're going to talk about metrics and KPIs.

Geoff, how are you?

0:24 Geoff Gualano

I'm doing well. Thanks so much for having me.

0:26 Stephen Brown

Geoff, you are my first repeat guest, other than my business partner Preston. How does it feel to be the first repeat guest on the Ecommerce Finance Podcast?

0:37 Geoff Gualano

Oh my God, I feel like I have the weight of the world on my shoulders, and I hope I do not disappoint. You of all people, my friend.

0:46 Stephen Brown

Well, we are hoping this is our third attempt at recording this episode. We've had some challenges. And so if you're listening to this, it's because we had success.

I know the CEOs of A2X, Jamie and Jamie, we're going to start a GoFundMe for Geoff to get him faster internet, because his up speeds are really struggling. No, just kidding.

Geoff, introduce yourself, who you are, and tell us a little bit about A2X.

1:12 Geoff Gualano

Yeah. So I run the go-to-market team at A2X, which is a combination of the marketing, revenue operations, and partner teams.

But I have been in the cloud accounting ecosystem for almost a decade now. So first at a company called Hubdoc that did receipt capture, which was acquired by Xero, so I spent some time at Xero as well. And now at A2X, I've been here for about four years.

1:50 Geoff Gualano

And we effectively, accurately automate ecommerce accounting. So if you're a seller on Shopify, Amazon, eBay, Etsy, Walmart, PayPal, we help you with your revenue reconciliation in your general ledger. So if you're using QuickBooks, Xero or NetSuite, we make that process automated, fast, accurate, so that you get data that you can trust and make decisions on.

We work with wonderful partners. Stephen, you're obviously one of our favorite partners at LedgerGurus, who collectively we work with to help provide financial visibility and clarity so that ecommerce businesses can achieve financial profitable success.

2:21 The four maturity levels

Stephen Brown

Awesome. We did an episode last year, early in our cycle of launching this podcast, around the accounting maturity model. And one of the things we've talked about is looking at that again, but with the framework of, what metrics do you need?

So why don't we start there. Can you recap for us what we talked about last time?

2:52 Geoff Gualano

Yeah. So I would say that most ecommerce businesses fall within one of these four maturity levels. And it's a progressive maturity model.

So you're getting started as an ecommerce business, you're making sales, and you're at level one. Which is, I need to be conscious of tax and compliance. So that's level one, ecommerce accounting maturity.

3:20 Geoff Gualano

Level two is, as you continue to scale, you want better visibility into your financials. You want to actually know what's happened in the business. So you're looking at accounting as a mechanism to understand what has happened. What are your sales? What are your fees? What are your refunds? What are your costs? And then how to move forward from there.

3:50 Geoff Gualano

And then the third level is, this tends to be as people get a little bit more mature, sometimes they're working with an outsourced accounting team like the LedgerGurus team, sometimes they're starting to bring in some finance folks in-house.

We call this one kind of the forecasting and budgeting stage of the maturity model. So you're not just using accounting to look at what has happened, you're using those numbers to project what might happen in the future and to build models against it.

4:20 Geoff Gualano

And then the last level of maturity, this is when you're really starting to scale, when you're looking at external capital, external investors, potentially lenders, where accounting becomes a mechanism to bring on that external capital.

We call it investor-ready financials, which effectively means that you have the right bookkeeping processes in place, you have the right definitions. Sometimes you're even starting to get into GAAP compliance, audit readiness, so on and so forth. So that would be level four.

4:50 Geoff Gualano

And again, as I mentioned, it's a progressive model. You're not one or the other, everyone goes through this journey. The only difference is how fast they go through it.

And then I would say not everyone gets to level four, really. And quite honestly, Stephen, you know this better than anyone. Even a lot of people who try to do level three without accurate foundational data, level three is like super, super hard.

5:11 Geoff Gualano

If you're watching this, you've probably identified where you stand within the maturity model. And I can't wait to start to dig in with you on what numbers are important for each, and how to think about them.

5:26 Level one, tax and compliance, and cash versus accrual

Stephen Brown

All right, let's walk through each level and talk about what potentially matters, and maybe the insights and issues around those measurements. So level one, tax compliance.

5:38 Geoff Gualano

Yeah, absolutely. I'd love to flip the question back to you, because I would imagine that tons of clients who are coming to your door, this is where they're at. And they're now starting to think about accounting a little bit more strategically, and they want to have their books in order so they can understand what's actually happened in the business.

5:50 Stephen Brown

Yeah. When I think about a level one mindset, they usually are focusing on two key metrics.

I think early on people have a revenue mindset, and they're usually getting that data out of their Seller Central, their Shopify admin portal, whatever other sales channel they have. Looking at revenue through that lens.

6:20 Stephen Brown

And then from a tax perspective, really the only thing you care about is profit. And oftentimes, depending on how mature you are, that could be like, well, here's my revenue. They go dump a bunch of receipts or virtual receipts on their tax accountant's lap and say, tell me what I owe. So they might not even know what their profits are, they just know that that's where their tax implications are.

And so it's a really basic mindset. Revenue, profit only insomuch as it pertains to taxes.

7:00 Stephen Brown

They're probably not watching profit on a month-to-month basis, but they tend to watch revenue on a month-to-month basis.

But even then, we can pull on this thread, because this is a world where A2X lives. Revenue is not as easily defined as you think. We talked about this on our last episode, but revenue in ecommerce can be hard to measure. Because people think, well, it's the number I see in Shopify. But in reality, that's not what I'm getting in my bank account in the same timeframe.

7:40 Stephen Brown

And this is one of the things that A2X solved, the reality of payout timing. You've got Shopify that's a couple of days, you've got Amazon that's a couple of weeks. If for some reason you're a stage one maturity and you're in wholesale, that can be a couple of months to get paid.

And so depending on what you're providing your accountant, if you're just giving them bank statements, you're not actually seeing the revenue when it happened. And you're not even seeing the net revenue. You're seeing net revenue after fees in most cases.

8:26 Stephen Brown

So even something as simple as revenue, when it goes from a sales channel portal to an accounting ledger, done right, is two different things.

Let me ask you, this is the world you guys live in. How often do you see customers get this wrong?

8:33 Geoff Gualano

Full stop, most people record revenue incorrectly.

8:40 Stephen Brown

That's true. In this world it's very complicated with ecommerce. And you could go up the maturity model and there's another level of revenue recording. But even at level one, what they might think is revenue that they're giving to their tax accountant, depending on what they're communicating, isn't their actual revenue.

9:00 Geoff Gualano

Yeah. The interesting thing is, and this speaks to A2X a little bit, but I'll talk about it conceptually.

Even if you are using an accounting solution like QuickBooks or Xero, and you're selling on Shopify and you're getting a deposit on your bank feed in QuickBooks, what we see most people do is actually go and record that deposit as sales, full stop.

9:34 Geoff Gualano

But the problem is that deposit from Shopify is so much more than your sales. It's your gross sales minus your fees, your refunds, your gift cards, your taxes, everything.

And ultimately, you know this, but that's where A2X comes in. We take that data, we organize it, we summarize it, and we post it, match it to the deposit, reconcile. So now you have an actual breakdown of all of those discrete transactions.

9:54 Geoff Gualano

But a lot of the time we see, in level one, people are recording revenue incorrectly, missing out on deductions, either over or underpaying. It has a lot of implications, the accuracy of the data that you're providing your tax accountant.

10:05 Stephen Brown

And it can work to a certain degree for tax accounting, but it definitely doesn't work when you move up into those other levels.

So level one might be recording revenue as deposits. The problem is when you move up to level two and three, not having accurately recorded revenue makes it very difficult to do good analysis on your business. So maybe that's a good bridge to level two.

10:42 Geoff Gualano

Let's talk about the bridge to level two, because I think there's another component, and one is accounting method.

So if you're in level one, we tend to see people strictly on a cash basis. And then once you get into level two.

10:42 Stephen Brown

Which is interesting, because you were telling me in Canada that you guys can't do cash basis for businesses. Is that correct? But here in the US, the Wild Wild West, we can do cash or accrual up until a point. There's a point where you have to do accrual, but when you're small you can choose your method.

10:56 Geoff Gualano

Yeah, you've got to do it accrual.

I mean, can you provide some clarification, I think, for the people that are listening specifically in the US? Because you see a lot of people in level two that are actually still doing cash. And now they're doing it imperfectly, because you and I would make a strong argument that you kind of should and need to be doing accrual.

11:20 Geoff Gualano

So first and foremost, can you talk about the differences between cash and accrual? And then the other piece is, what is that threshold that you need to pass when you need to transition from cash to accrual from an IRS perspective?

11:38 Stephen Brown

Yeah. So the best way I would describe it is, accrual based accounting says I am going to record revenue, there are a couple of key principles, I'm going to record revenue and expenses in the period that they occurred.

So if I sold a product, I'm going to record the revenue when I sold the product, not when I received the cash for that sale.

12:10 Stephen Brown

A good example for ecommerce with expenses is, I am going to record cost of goods sold, which is the product that I sold, when I sell a product, not when I bought the inventory.

And so those are some concepts that are a little bit confusing to the non-accounting educated person, because it seems a little counterintuitive. But the idea is you want to reflect that in that period.

12:40 Stephen Brown

Cash basis is going to be, I'm going to record something when it hits the bank account. And in ecommerce it gets totally problematic because of the deferral of payouts for revenue, and inventory to COGS, that cycle, which is where people really struggle.

The way that accrual accounting would be, I buy the inventory, the inventory goes onto the balance sheet as an asset, and it comes off of there as a cost of goods sold expenditure when I sell the product.

13:05 Stephen Brown

Which for a lot of people is just like, why do you do that? Well, the idea is it gives you a better sense of actual profitability. Because if you don't do it that way, your profits are really weird and unrealistic, and you don't really know what's going on in the business. Which is why I think key to level two is accrual accounting.

Now, the other question you had was, what is that threshold? I don't have that off the top of my head. I want to say it's $20 million. I could look it up on the internet.

13:23 Geoff Gualano

I think that's the range. I thought I was going to say 25 off the top of my head. Actually, we have access to the internet, so let's look it up.

13:42 Stephen Brown

Yeah, I'm looking it up.

It looks like it's the Tax Cuts and Jobs Act raised the gross receipts threshold to 25 million, which has since been adjusted for inflation to 30 million in 2024, and 31 million in 2025, and 32 million for 2026. That is if Google's AI mode is accurate, which it probably is.

So yeah, it's a big number, you could get away with cash accounting. Honestly, if you're running your business at 20 million and you're cash accounting, that's all I can say.

14:20 Geoff Gualano

Yeah. Well, we say this all the time, obviously, as A2X, but I'm sure you do as well.

Accrual comes into place once people want to build a solid foundation that they can scale on top of. So if you're building an ecommerce business with plans to grow, the sooner you get onto accrual, the better off you will be over the long term. Because you'll be comparing things year over year using the same set of principles, the same definitions, so on and so forth.

14:56 Geoff Gualano

So we see tons, although those are really high numbers, we see so many million dollar sellers, even half a million dollar sellers, jump onto accrual as soon as possible.

And then actually, Stephen, I'm going to make this statement. Most second time founders do it from day one. Most second time founders, one of the first things that they get set up is their accounting, and they do it from an accrual perspective.

15:21 Stephen Brown

And I think as we jump into level two here, I'm going to try and explain what the unlock is. So should we go there next?

15:24 Level two, understanding the business

Stephen Brown

So I'm glad we started with revenue. I think paramount to level two is accrual based accounting, and revenue. So making sure that I am recording the revenue when it happened, and actually revenue, not the payouts. Because the payouts hold back oftentimes merchant fees. With Amazon it's FBA fees, could be Amazon ads. And so you might get a fraction of what you actually sold.

16:00 Stephen Brown

Now, why is that important? When I start moving into level two, which is really understanding my business, one of the things I like to do on a profit and loss basis is what's known as income ratios, where I'll take a spend and divide it by the income.

The most common one of these is the gross margin or the net margin, your bottom line profit margin. So you always hear about gross margin, your gross margin being your sales minus your cost of goods sold, which is your gross profit, divided by that income.

16:40 Stephen Brown

And the value of measuring percentages versus raw dollars is, percentages will cut through volume, and you can benchmark what is a good percentage.

So getting that revenue right allows me to measure some key ratios on the profit and loss, or the income statement, and benchmark those ratios against what is good.

16:56 Geoff Gualano

And such is volume. It's also seasonality. Cuts through a lot.

16:59 Stephen Brown

Volume, seasonality. If you're just looking at, oh my gosh, my gross margin went up by 100,000, that isn't as important as, what was my gross margin as a percentage of income?

17:14 Geoff Gualano

Yeah, 100%. And I know that you did this in a recent episode, and I don't know the mechanism in which you post the podcast, but I would definitely click on the link in the description below. You guys did a great episode on the margins that you should be tracking as an ecommerce business, and you really went into depth there.

17:26 Stephen Brown

Well, I think this is so important that, if you're a repeat listener, I'm going to revisit this. You and I talked about this last time, but there are a couple of key metrics on the income statement that I like to look at. Should we go through those?

17:39 Geoff Gualano

Yeah, I would love to, honestly.

And also, I don't know if anyone saw that podcast, by the way, with Matt Damon and Ben Affleck on the Joe Rogan podcast. And they were talking about that. Did you see it?

18:00 Stephen Brown

No, I did not.

18:03 Geoff Gualano

Okay. So there's one concept, because we are repeating a concept from our previous episode, but they talked about this.

When Netflix provides guidance to its writers, they understand that their audience is sometimes distracted on their phones, so on and so forth. So now if you're watching a Netflix show or a movie or whatever, the guidance is that you should repeat the plot at least three times.

So as you go over this again, I've got Matt Damon in the back of my head talking about repeating the plot. I think it's valuable because it's so important.

18:28 Stephen Brown

Well, and also if you don't come with an accounting or finance background, some of these concepts can be hard.

So one of the first things I look at, if I'm doing accrual based accounting, let's start with revenue. So I have more accurately measured revenue. I like to look at seasonality of revenue. When do I have peaks? When do I have valleys?

19:00 Stephen Brown

For a lot of consumer brands, Q4, especially November, December, it's going to be a high sales period. January tends to be abysmal unless you're a winter products brand. And then depending on the type of product, there might be different peaks and valleys throughout the year.

And that's really important to understand, because how you play your marketing strategy, planning your inventory, which kind of gets into level three, but you need to start understanding those patterns because they will inform you how to think ahead.

19:40 Stephen Brown

So that's one of the things I think about with revenue.

We have a basic dashboard that we give to all of our clients. So we look at revenue, visualize with trends, we look at cost of goods sold or gross margin, those are two sides of the same coin.

20:00 Stephen Brown

So cost of goods sold, and the way we define cost of goods sold, and the way that accounting defines cost of goods sold, is your product costs. So your cost of manufacturing, importing the product, shipping it, paying duties and customs, which became a really big deal this last year for the US. Those are the costs that we consider cost of goods, and that generally accepted accounting principles would agree upon.

20:40 Stephen Brown

Now, why do you want to measure cost of goods sold that way, versus what I see a lot of times is people putting selling costs into COGS? Well, that's a standard. So if you're talking to a banker, if you're talking to an investor, if you're selling your company, and you're measuring that consistent industry standard way, they understand what they're looking at.

21:10 Stephen Brown

And typically what they're looking for is a gross margin of between 40 and 80%.

The lower end is more common I see in resellers. So somebody that goes out and sources a product and they're one of many people reselling that product. They don't have a lot of pricing power. Therefore pricing tends to normalize, and what happens is gross margins tend to be lower, which means it's harder to advertise. So in that case you're capturing demand through SEO, through product listings, less cost intensive ways of capturing.

21:45 Stephen Brown

Whereas if I'm a direct to consumer brand, I have more pricing power. I might be the only one that can sell the thing that is branded XYZ. And so I put more energy into brand, and I have to put more energy into awareness of my product.

What typically happens is there's a correlating relationship between a level of advertising spend and the gross margin. Higher gross margin, the more you can spend on advertising. The lower gross margin, the less you can spend on advertising.

22:05 Stephen Brown

And that's probably a good bridge into the next metric, which is advertising. So I like to look at advertising as a percentage of income. And I just walked through that relationship with COGS. So that's really important to follow.

22:12 Geoff Gualano

Just a question for you. Do you look at ROAS as well from that financial dashboard that you put together, or do you let the business kind of handle that on its own?

22:22 Stephen Brown

We haven't been getting into ROAS. That's really kind of marketing land. I think from the finance land, there's a bridge between marketing and finance. Finance I think is going to be more looking at the impact of marketing overall.

But if you wanted to peel back the layers of, why do I have a higher marketing spend as a percentage of revenue? That's when you start to peel back and say, well, let's look at ROAS. What is our new customer acquisition cost? What is our return customer cost per acquisition?

23:00 Stephen Brown

The marketing land has so many metrics, and great marketers really understand those. And then at the end of the day, when you're looking at all these campaigns, they should roll up into an overall spend as a percentage of revenue that gives you a benchmark of how we're doing.

23:20 Stephen Brown

And I think every one of these categories, there's a double click down, usually into an operational system. If I want to double click into my COGS, I'm going to be looking into my inventory management system. I might be drilling into duties and fees.

And so the financials can give you a sense of, am I doing well? And if the answer is no, I usually want to go down. That's where you get into that next layer down. And that stuff usually doesn't live in your financials.

23:48 Geoff Gualano

Yeah, and I'll add a point, and maybe a little tangent here. I think a lot of the marketing metrics that are tangentially related to financials, they tend to be looked at more frequently.

I have a question for you, Stephen. All these financial metrics, how often do you and your clients look at them for them to provide value? Is it once a month, multiple times a month? What's the relationship comparatively to a marketing metric, as an example?

24:20 Stephen Brown

I've got this three-way relationship that I like to think about. Let's say it starts with financials and quality measures. And this kind of gets into level three thinking, but I'll put forward this concept now.

Here's how I did, this is the final score. And then I use that to inform my plans. And then I measure execution of my plans using more operational systems. So I've got my marketing dashboards where I'm real-time tracking performance of ads and ad campaigns, and I'm making adjustments accordingly.

25:00 Stephen Brown

So the financial stuff is really kind of a once a month cycle. And then the planning, you do a big push once a year, then you're usually reviewing and tweaking once a month. And then that third component, that's a daily thing.

But you don't drive your business out of your financials. The financials validate the other things, and you want to correlate those systems.

25:16 Stephen Brown

So you need to understand how a marketing system is going to correlate to that. Let's just take marketing for example. If I wanted to watch, I would probably be saying, we want to hit a certain percentage of revenue. They have the data to do that. We want to spend X amount of dollars on advertising for sales. That's probably what I'd be watching day to day. And you can usually do that in a marketing tool or a marketing analytics tool.

25:52 Geoff Gualano

So then the TLDR and the answer to that one is, although marketing metrics are significantly more frequent, daily, hourly, the financial metrics are usually once a month, the ones that you're referring to here.

So you just went over advertising. What are the next ones?

26:06 Stephen Brown

The next one I would look at is, I want to look at my fulfillment costs as a percentage of revenue, and that usually should be about 10 to 15%. It's hard to get it lower than that. If it's higher, it's usually it's too big, too heavy. That's kind of my good benchmark.

26:39 Stephen Brown

And then usually in a basic view, then I'm looking at my bottom line profitability.

If I have good metrics, we did a recent episode where we talked about some key margins, like contribution margin, which would be looking at the dollars after my cost of goods sold, my fulfillment. I would argue you should consider advertising, but you could make an argument either way. Everything, the dollars I have to spend when I sell.

27:10 Stephen Brown

If I have good contribution margin and I don't have good profit margin, it's usually one of two things. I may be spending too much on payroll, or I may have huge debt issues that are dragging me down.

So those are the basic metrics I look at on a profit and loss.

27:40 Stephen Brown

Then on the balance sheet, obviously tracking cash, and I want to start paying attention to inventory. What are my inventory balances? I might be looking at other things like debt balances, accounts receivable balances if I'm doing AR, accounts payable balances.

So those are some of the things on the balance sheet.

28:00 Stephen Brown

Usually when somebody's ready to go higher level, I'll bring in more income ratios. So we'll look at, how much am I spending on operating expenses, payroll, interest expenses, trying to understand better what is driving profit or loss. But then I'll also expand the balance sheet, I'll really start to look at those things.

28:26 Stephen Brown

And then there's a concept that spans both financial statements, which is the cash conversion cycle, which is one of my favorite things.

And this is measuring three things. A days inventory outstanding, how long does it take from the time I start paying for inventory to where I start selling the inventory? A days sales outstanding, how long between the time I sell something and I receive the cash? And we've talked about that briefly, but if you're selling online that's not immediate. There's usually anywhere from a few days to a few weeks. And when you get into wholesale, that can be a few months.

28:53 Stephen Brown

And then the one that can positively benefit you is your days payable outstanding. How long does it take me to pay people? And the longer I can hold off, the better it is.

But that cash conversion cycle is a number of days, and it essentially represents how long do my dollars get tied up in the system of the business before they come out in the form of sales.

29:20 Stephen Brown

And the way I like to think about that is, the longer that cycle is, the more likely I'm going to have to fund the business, either from profits or debt or investments. I've got to fund it from somewhere.

And so that's a really important complex concept that I have been trying to have more and more conversations around, because it's become more and more of an issue the last few years.

29:26 Geoff Gualano

Yeah. And I'd imagine that some people that are listening, they either are aware and tracking these metrics, or other people might be totally mind blown.

But I think the TLDR on level two is that everything that you've just gone over effectively gives you the information on if you're running a financially healthy business or not. And when you look at each of those metrics in a silo, they effectively give you information in terms of what you should address, what you should change, what decisions you should make.

30:00 Geoff Gualano

We'll get into level three for a bit, but I do want to say that the other benefit of level two is, not only do you understand the financial health of the business, and it gives you a jumping off point to make decisions on and plan and forecast in the future, it also helps with level one. It helps better position you for your taxes and compliance. Helps you pay the right amount, not more, not less. Which I think is a benefit that sometimes people miss or forget.

30:32 Stephen Brown

And I could summarize all these metrics into two buckets.

Profitability. How profitable am I, and why or why not am I? Those income ratios are telling me why it is I'm potentially not profitable.

And then the second one is around cash and cash flow. That's another thing I do, is I'll look at cash, usually do a cash flow metric, cash conversion cycle, cash balance, inventory balance.

31:02 Stephen Brown

People will be like, I say I'm profitable on an accrual basis, but I have no cash. And I'll go straight to the inventory balance and I'll be like, this is where your cash went. All that cash you made last year moved over, it's sitting on the warehouse shelf. And it's a million dollars, it's $2 million, it's $10 million. It's sitting there on the shelf, or it's on the boat, or it's in the factory, you prepaid for it, it's being manufactured.

And that's one of the biggest issues these businesses have, is cash and cash flow.

31:35 Drilling into channel and SKU

Geoff Gualano

I think what's interesting too is, we're talking about these metrics at the business level, but you can go a little deeper. There are tools that allow you to do it, like A2X. [unclear]

31:41 Stephen Brown

Yes. You guys have launched a product called Clarity that allows you to drill down into channels, into SKUs.

If you don't like your profitability, how am I doing multi channel? I used to see this more in the COVID peak era where people get on every channel. There's a cost of being on every channel, how profitable am I? Or they get SKU crazy. They're like, I love products, but how many products are actually moving the needle?

32:15 Stephen Brown

And you guys have introduced some capabilities to measure channel and SKU level profitability, as well as some additional insights, that double click that I talked about earlier. Okay, I know where the problem is. What's happening? Got to go deeper.

32:29 Geoff Gualano

Yeah, 100%. And this is where you can make informed decisions, where you can update your pricing strategy, where you could potentially kill off some SKUs. We've seen people who are offering free shipping cut that when they saw how much it was chipping into their profitability.

32:47 Geoff Gualano

The data, those metrics that you were talking about earlier at the business level, super helpful in making informed decisions. Am I profitable? Why am I not profitable? And then once you do the double-click drill down, you can make some really bespoke decisions related to very specific parts of the business.

33:06 Stephen Brown

Yeah. And it just becomes this cycle like I told you about.

Again, this gets into level three, and maybe this is the bridge to level three. But when you get those insights, you need to do something with them. You need to take action.

And like I said, I have this three part cycle of measuring the outcomes, doing something with them from a financial standpoint, that's budgeting and forecasting, but behind budgeting and forecasting is taking action on the business. And then real time measuring what's going on, and then validating that real time measurement and those budgets and forecasts to see, did I actually do what I thought I was going to do? And then just repeat continuously.

33:47 Level three, planning and forecasting

Geoff Gualano

Yep, 100%. So let's bridge into level three. I think it's a good segue.

So level three, as a reminder, is, okay, now that I understand what's going on in the business, because I've got accrual accounting set up, I'm doing this on a regular and consistent basis, I have a lot of the metrics that you were just talking about, you're now using this as a jumping off point to look into the future, to make decisions, to plan, to forecast, to budget.

34:20 Geoff Gualano

Before we get into it, I do have one question. How important is accuracy as part of level two to do level three well?

34:30 Stephen Brown

I think level two is where accuracy really becomes important. Because first of all, I talked about those ratios. But then if we get into financial exercises of cash flow planning, cash flow forecasting, profit planning or budgeting or forecasting, depending on the terminology you like to use, I need that data to be able to make those projections.

It's a lot harder, very cost intensive, to build those projections without good foundational financial data. They allow me to take some shortcuts and focus on the things that are less determinate. And so yeah, they're critical. And accurate.

35:03 Stephen Brown

If they're not accurate, you can't use them.

35:10 Geoff Gualano

100%. And I think it's funny, here's another difference between the marketing and the financial piece, although there is a lot related.

In marketing, you can use directional data to make investment decisions. What channels to invest in, what tactics to double down on. But when you are cash flow forecasting, when you are budgeting, when you are projecting into the future, it's incredibly important.

35:39 Stephen Brown

Or doing another thing you do on this level, which is scenario planning.

Hey, I want to go into this new channel. You can do a one-off analysis of what would happen here. I want to hire somebody, what are the implications of that? I want to expand into a new product line. You need that foundational data to do that.

35:47 Geoff Gualano

I totally agree. We used to have a marketing message that close enough is never enough in accounting and tax. And it's really clear why that is in the tax world. But I think it's just as clear in the accounting world, especially as it relates to level three.

36:10 Geoff Gualano

So let's step into it. A lot of the time I know that you provide fractional CFO services for some of your clients as well, because we're now getting into CFO land.

Some external accounting firms provide these services, sometimes you're starting to bring this in-house. What type of reports are you putting together to look into the future?

36:35 Stephen Brown

So I've talked about some of the activities that you do in corporate land, that's called FP&A, Financial Planning and Analysis. Essentially you're building budgets, projections.

The way I like to translate this to small businesses is, I'm trying to say, what do I think the future is going to be based on what I'm going to do? And to do this you have to start thinking ahead. What are we going to be doing? What's my marketing plan? What's my product plan?

37:10 Stephen Brown

These aren't metrics, but these are activities. So it starts with a revenue and marketing plan that drives, what inventory are we going to have to purchase for that? And then I start putting all that together into a budget. And then I can start doing either long-term or short-term cash flow projections.

And that's time consuming and it's expensive. And so how do I use that?

37:50 Stephen Brown

Well, there's something I heard, actually heard it from Taylor Holliday, who came to one of the events that you guys hosted and has a really great podcast, Ecommerce Playbook. He tells a, there's a quote, and I've started using it, some guy said, all plans are wrong, some are useful. Which I think is a really great concept.

38:15 Stephen Brown

So what do these plans do? Because you never hit your plan perfectly, but it's a mental framework for what we think is going to happen. You go through this exercise, and the more thorough the exercise, the more accurate it might be. And you might say, I don't like what I'm seeing here, what changes should we make?

38:40 Stephen Brown

But once you lock that plan in, then we start getting into metrics. What's the most important metric with plans, which is measuring against plan, or in finance nomenclature, budget versus actual. So I budgeted this and I achieved that.

And by measuring that metric, then what I want to start doing is start saying, why? Okay, I was off on revenue, up or down. Why? My COGS were higher than projected. Why? We got in the crosshairs of a political spat, tariffs went up, I had inventory that got hit. Or, hey, profits were down. Why? Well, we ended up hiring two more people that wasn't in the plan, what do we need to do to adjust?

39:20 Stephen Brown

So budget versus actuals, I think, is the key metric in this phase three. Because you're trying to say, how did we do against the plan? And then learn from where you're off, because you're always going to be off. What's more important is understanding why you're off and making those adjustments.

Stuff happens. Like last year, tariffs. I think we all thought tariffs were going to happen at the beginning of 2025. We had no idea how intense they were going to be.

39:49 Geoff Gualano

You even projected that. You had a lot of great projections, most of them were right. This was one where you'd probably grade yourself a little bit lower, right?

39:55 Stephen Brown

I had no idea they were going to be as severe as they were.

Or I'll give you an example. My business partner Preston, who I do episodes with periodically, we've been seeing our gross margins erode and we're like, I think it's tariffs. But we started digging in deeper. Again, that's the double click. Well, what else is going on?

40:30 Stephen Brown

And we started noticing the exchange rate we're getting, because we import from Italy. That exchange rate has deteriorated significantly over the last few years. We were getting, I think it was like 93 cents on the dollar a couple of years ago, and we just did a purchase the other day, it was 81 cents on the dollar.

And we're like, start doing the math, and we're like, well, where does that go? If I don't raise prices, that is increased COGS, decreased gross margin.

40:49 Stephen Brown

And so we're starting to have currency trader conversations like, well, what do we do to hedge currency issues? Or how do we need to think about this? What pricing do we need to do?

And so that's where having a plan and measuring against actuals and saying, hey, we got off, why? And then you start drilling in, you start learning, and then you can start taking actions. Let's raise prices, what happened?

41:18 Geoff Gualano

It speaks to why level two is so important, and why this is a progressive model. It is not one or the other, you need to go through every step. Because I love that example, because you went back to a level two metric to understand what was happening, to be able to make an informed decision on how to adjust.

41:21 Stephen Brown

Yeah, it is. And it iterates. The more you'll start asking more and more questions.

There's this drill down, because you're going to ask why. Why did this happen? I don't have the information. Okay, we need to start measuring it, or we need to do an analysis.

And then the goal is action. The goal is, how do we adjust? How do we improve, instead of being at the mercy of systems or policies that you don't control? You understand implications. When changes happen, you understand the implications. A supplier raised prices, we need to do something.

42:13 Geoff Gualano

It's also interesting because what we're talking about now is, I think, at the front of mind for many ecommerce business owners.

In fact, for example, we're seeing demand for A2X increase year over year. I know that you and a lot of our other accounting partners are also starting to see the same.

42:40 Geoff Gualano

And it's interesting because we're past the ecommerce boom during COVID. Everyone was starting an ecommerce business, it was hard not to be successful in that environment. But what's also true in that environment is that people didn't really care about their accounting as much, because revenue kept going up and cash in the bank kept going up. So when that's happening, you don't really need to double click and understand all of the inner mechanics of the business.

43:00 Geoff Gualano

And what we're seeing now is, because the environment's getting more challenging, because of geopolitical environments, tariffs, currency, the US dollar is a really great example, you've got to be drilled in. And that's why the accounting piece becomes so critically important.

43:19 Stephen Brown

Yeah. Five, six years ago sales were easier, marketing was cheaper, lending was cheaper, tariffs were not a really big deal. They kind of were from the first Trump administration for China, but it wasn't this global thing.

And all that's changed. I think we're in the era of the sophisticated seller, where you need to level up on multiple fronts. And finance and understanding your business is one of those. It's a key one.

43:57 Geoff Gualano

Well, you talked about Taylor Holliday two seconds ago, but I think he's a great example. He speaks about finance almost just as much as he speaks about marketing, because that's the environment that we are currently in.

44:26 Level four, investor ready, and thin slicing

Geoff Gualano

Okay, so that's incredibly helpful context. Let's segue into level four.

Let's assume you've got your level two in order, doing a great job, tracking the right metrics and you're doing so accurately. The perfect world scenario that you had mentioned to lead us into the conversation. Level three, you now have a plan and you are measuring actuals versus budget versus plan, and then drilling into the numbers when you have to and adjusting as necessary.

44:50 Geoff Gualano

Level four is when we talk about investor ready financials. The sophisticated ecommerce business owner is getting external capital.

So before, all the levels, those numbers were very internal. When you're in level four, investor-ready financials, you're now starting to share those numbers externally. Can you talk to me about the definition, and what your books need to look like if you are starting to look into third party investors, if you are starting to look into lending, if you are starting to look into M&A?

45:29 Stephen Brown

Yeah. And sometimes you can skip three and go straight to four, maybe you haven't built out that sophistication.

But I think one of the biggest things you look at at this level four is a level of accuracy and confidence in the data. They're going to be looking at, are the metrics audited? Are they reviewed? They may need some of those level three projections.

46:00 Stephen Brown

They may want to know how you did against budget versus actuals. Not always, but that's a good selling point. Hey, we projected this and this is what we did. That will raise their confidence.

So it's like the culmination of the previous three levels. Do I have the right measurements? Do I understand my business really well? Am I performing well? Can I communicate about my business? Now they'll go in and they'll do their own assessments.

46:36 Stephen Brown

But there's a level of salesmanship. Whether it's, I'm going to a lender, I've got to provide financials. Banks know when you have crap financials, there are things that they can look at.

We as accountants can go in, depending on your accounting software, we're particularly familiar with QuickBooks Online, I can tell you pretty quickly if it's good or not. When was the last time it was reconciled? If I see some of those ratios moving around a lot, I'm going to ask questions about that. And if somebody doesn't have a good answer, I know, okay, they don't know what's going on. Maybe they're not measuring accurately. Maybe there is volatility.

47:20 Stephen Brown

And so having that accuracy and the confidence of the data, I think, is the most key part of level four. And so as a metric, it's probably less about a specific number you're measuring, and more of an implicit confidence that comes from an audit, a review, et cetera. Being able to speak to the previous levels.

47:36 Geoff Gualano

Yeah, it almost feels like you need to have a standardized bookkeeping process. You need to have standardized definitions of every metric. You need to have a tech stack that is believable and accurate and integrated. There are just so many pieces to this puzzle.

48:02 Geoff Gualano

And what I like about level four is, okay, level three, you might have an in-house finance team, you might be outsourcing. Once you get to level four, it's always good to get a second pair of, an outsourced accounting team can help you significantly.

We partner with you guys and tons of other accounting practices that really help set businesses up for investor-ready financials, for M&A, for lending, so on and so forth, because of the instincts that you guys have.

48:31 Geoff Gualano

Are you familiar with Malcolm Gladwell? I'm sure the answer is yes. Are you familiar with the concept of thin slicing?

48:36 Stephen Brown

I'm not. Tell me about thin slicing.

48:38 Geoff Gualano

So thin slicing was in his book, I think it was titled Blink, I'm so sorry if it wasn't.

But it's this idea that, he uses an example where a museum bought a fake painting and they had a lot of art historians come in and evaluate the painting. And the best art historians, right away they knew it was fake. Saw it, they knew it was fake.

49:05 Geoff Gualano

And they were like, why do you know it's fake? And they couldn't articulate why at that moment in time. But then as they looked into it and they evaluated it, they could clearly speak to why it was fake.

And the reason why is because throughout their careers they've amassed this tremendous amount of context and information that allows them to make informed decisions with incomplete information, because they're thin slicing. So they're compounding all of this information into these very quick decisions that are actually rooted in a ton of previous context.

49:47 Geoff Gualano

It's confused for intuition. It's confused for instinct. It's not those things. It's decisions or feelings that are based on the fact that you're very experienced in that environment.

And when you said, I could look at a QuickBooks file really quickly and know if the numbers are good or not, or how the business is performing or not, I thought to myself right away, this is, he's thin slicing.

50:09 Stephen Brown

Yeah. Well, I'll give you an example.

We have this basic dashboard that has six metrics, and I've shown it to you before. I've been doing these trainings with my team where I'll go in and we'll do case studies, and they'll ask me questions and then I'll say, here's what I'm seeing about their business. And I'll describe it and I'll be like, are they doing this? Are they doing this?

50:38 Stephen Brown

And their minds are blown that I understand their business just from looking at six metrics. And it's like, yeah, because there's a pattern.

And I can be like, something happened here, did this happen? How did you know? And I'm like, well, because there's a pattern.

51:00 Stephen Brown

And so when you start to learn those patterns in your own business, that's when the power unlocks, because it now enables you to take action.

The key to great outcomes, we talk about level four, whether it's getting the best lending possible, the best investment possible, the best sale of the business possible. It's fundamentally rooted in understanding your business, understanding what you're doing well, being able to articulate that, being able to understand what those parties need and provide that for them.

51:40 Stephen Brown

And when you can do that, you're going to get better outcomes. Whether it's a better sale of the business, so they're like, this person knows what's going on. They really understand their business really well, they seem to be executing really well, it's proven in the financials, they're vetted. They're going to be willing to pay more.

Whereas if they come in and they ask you a question and you can't answer it, they're like, okay, I know there's probably some work to do here, because they don't understand their business really well.

52:01 Stephen Brown

A good example. Do they have Shark Tank in Canada?

52:01 Geoff Gualano

Yeah, they do. I think they call it Dragon's Den. Yeah, it's called Dragon's Den in Canada.

52:04 Stephen Brown

Dragon's Den, that's what it is. They call it Shark Tank here.

That's a great show to watch. If you watch Shark Tank and you're like, if I were to go on Shark Tank and I can't answer the type of questions that they would ask me, you need to level up. Because that is the type of thing that allows you to sell your business or get investment.

52:40 Stephen Brown

They're not asking crazy things, but they're asking you to really understand your business.

I love that as a case study. I'd say to anybody that wants to level up, go watch Shark Tank. And if you couldn't do what the businesses that are getting funded are doing, or Dragon's Den, then that's something for you to work on.

52:51 Geoff Gualano

I love that example. Can I double-click on it really quickly?

So you need to answer those questions a hundred percent. I saw a video with Mark Cuban and they asked him a question, of all the deals that you say yes to in the moment that we see on TV, how many do you actually follow through on?

53:10 Geoff Gualano

And he said, I think he was like 60, 70, it wasn't all of them. There was a meaningful percentage that they didn't follow through on.

And the reason why is because the numbers that were shared in the pitch were either misrepresented on purpose, or more often than not by accident, because the numbers weren't accurate and they didn't know. They thought that they knew.

53:30 Stephen Brown

Yeah. What do you think those guys are scribbling down? Because you watch, they're writing stuff in notebooks. They're probably writing down those metrics that are being communicated. And then they're handing it off to their teams that do investments and say, go validate that. Go validate that that was accurate.

Because if it is accurate, that's why they get excited. What do they get excited about? Numbers. They don't care about products that much, until you put the numbers behind them, then they go, ah, that's it.

54:01 Stephen Brown

And so there's the diligence phase. And if what they got excited about was real, that's when investments and acquisitions happen.

54:15 Geoff Gualano

10 on 10, it's not an analogy, it's like 10 on 10 use case context.

Hey, I really appreciated this chat. We went through a ton. Any other questions for me? I don't really have any more questions for you.

54:24 Stephen Brown

So let's land the plane. I think we've gone through the levels.

So I think my final advice would be, regardless of where you are, keep moving forward, keep progressing. If you're like, that sounds really hard, it's a journey. Now we've given you the journey of maturity, now we've given you the journey around metrics to look for. Just keep going on that path of maturation, because that's how you're going to have great outcomes.

All right, let's call this a wrap. Geoff, if somebody wanted to connect with you, what's the best place to do it?

55:03 Geoff Gualano

You can find me on LinkedIn. Or if not, it's Geoff, G-E-O-F-F, at A2XAccounting.com.

55:11 Stephen Brown

Okay, thanks, Geoff. We're going to have to do this again.

55:13 Geoff Gualano

Thank you, talk to you all soon.